ENTG - Entegris Cannot Afford A Letdown Or It Is Down She Goes

2023-07-26 06:22:49 ET

Summary

• Entegris has see-sawed in recent weeks after a major rally, but attempts by the stock to break lower have been snuffed out by buyers.
• A catalyst may be needed to break the current status quo, which means the upcoming earnings report carries an extra weight that could shift sentiment.
• A good report could go a long way towards replenishing the fuel needed for a continued move higher, but a bad report could accomplish the opposite.
• Some may want to play it safe by reducing exposure since a lot is riding on the Q2 report, and the risk of falling short is out there.

Entegris ( ENTG ), a supplier of materials and process solutions for the semiconductor industry, is scheduled to release its Q2 report on August 3 at what could be a pivotal moment. The stock soared higher in May with the assist of multiple catalysts, but the stock has shown signs of wavering in recent weeks. ENTG has to follow up on what it started or the latest rally could shift into reverse. Why will be covered next.

Why ENTG needs a follow-up and why it cannot afford a letdown

ENTG made a big bet with last year's acquisition of CMC Materials for roughly $5.7B in stock and cash, but this also resulted in ENTG taking on billions of debt with interest rates on the rise. If that wasn't enough, the semiconductor market fell into a downturn at about the same time. This downturn affected demand and thus sales at a time when ENTG needed to begin servicing the debt it took on to acquire CMC. A previous article goes into further detail as to the challenges facing ENTG.

ENTG fell into a predicament by making a major acquisition just when the semiconductor market turned south, but it has taken steps to try to fix the issue. ENTG has started selling off some of its assets, which can be used to raise cash and pay off debt. The latest transaction involves the $700M sale of the Electronic Chemicals unit, acquired by ENTG as part of CMC, to FujiFilm, which ENTG announced on May 10. This transaction follows the earlier sale of QED Technologies for $135M in January. The QED proceeds were used to pay off a bridge loan in April.

The sale was followed shortly thereafter by the release of the Q1 report on May 11 that was better than expected. The asset sale and the earnings report helped power a 19.6% jump in the stock on May 11 as shown in the chart below. The rally shifted into another gear after May 24 when Nvidia ( NVDA ) blew past estimates thanks to strong demand from AI, which some speculate could rub off on ENTG. The stock is now up 59.9% YTD with almost all of it coming in May.

However, notice how the stock has struggled to go higher since then. In fact, the stock is now 0.3% away from falling below the 50-day moving average, which many keep track of and which may convince some to abandon their bullish stance. On the other hand, there seems to be quite a bit of buying interest at $105 or so because the stock has bounced whenever it has reached that price level in the last two months. Still, the stock has gone sideways and a catalyst may be needed to change the status quo.

It's also worth mentioning that multiples are higher than they have been in recent times. For instance, ENTG trades at 41.9 times forward non-GAAP earnings with a trailing P/E of 31.5. In comparison, the median in the sector are 23.6x and 19.5x, respectively. Current multiples are also above the average in the last five years at 27.6x and 29.1x, respectively. Elevated multiples could contribute to the necessary conditions for a possible correction in the stock.

Source: Seeking Alpha

What the market is looking for from ENTG

That catalyst may come in the form of the Q2 report. If the stock is to continue higher, the upcoming report cannot come up short or that could power the stock lower. It's therefore worth mentioning that there have been about as many upwards earnings revisions as downwards revisions in the lead-up to the Q2 report. With about a week to go, consensus estimates expect ENTG to come up with non-GAAP EPS of $0.57 on revenue of $887M in the Q2 report. This is somewhat higher than the midpoint of guidance from ENTG as shown below.

Source: ENTG Form 8-K

The expected numbers in Q2 are somewhat worse than those in Q1, which in turn were worse than those in the preceding quarter as shown in the table below. Keep in mind that Q1 FY2022 preceded the CMC acquisition and therefore does not include any contributions from CMC, unlike Q1 FY2023 and Q4 FY2022, which is skewing the quarterly comparisons.

On a pro forma basis, Q1 FY2023 revenue declined by 4% YoY instead of the reported 42% YoY increase. Furthermore, the GAAP loss in Q1 FY2023 was primarily the result of a $88.9M goodwill impairment related to the impending sale of the Electronic Chemicals unit and various other integration and restructuring costs.

Adjusted EBITDA in Q1 FY2023 was $251.5M in Q1 FY2023, up from $206.2M in Q1 FY2022, but down from $261.2M in Q4 FY2022. Keep in mind that this number excludes, among other things, interest expense, which was $84.8M in Q1 FY2023. Interest was just $12.9M in Q1 FY2022, which reflects the change in the debt situation.

Source: ENTG Form 8-K

What the market may pay special attention to

A big reason why the market liked the Q1 report was because it provided a detailed outline of what to expect from the rest of FY2023, on top of what Q2 guidance called for. The outlook from ENTG calls for Q2 revenue to be the low point, followed by modest sequential increases, resulting in a second half that is flat compared to the first half. FY2023 revenue is expected to decrease in the high single digits and non-GAAP EPS is expected to be at least $2.30 after $1.18-1.23 in H1. From the Q1 earnings call:

Looking at the rest of 2023, forecasting the industry this year continues to be challenging. However, based on discussions with our customers and using third party estimates, we expect that semiconductor fab utilization will likely bottom in Q2. For the full year 2023, we now expect the market will be down in the mid-teens or a bit more than the down 13% we cited on the last earnings call.

Given our strong position in the new technology nodes, we now expect to outperform the market on a pro forma basis at or slightly above the high end of the 3 to 6 points outperformance range target we discussed in our recent Analyst Day.

Putting it all together, we continue to expect our pro forma sales in 2023 to be down on percentage basis in the high-single digits.

Wrapping up our outlook for 2023, we also continue to expect EBITDA will be approximately 27% to 28% of revenue for the year. And we expect full year 2023 non-GAAP EPS to exceed $2.30 per share."

A transcript of the Q1 FY2023 earnings call can be found here .

The market will be curious if ENTG is sticking with its outlook or if there are any changes, especially after what TSMC ( TSM ) had to say in its latest report on July 20. Note that ENTG dropped 4.5% on July 20 after TSM lowered its FY2023 outlook due to weaker-than-expected demand. ENTG is more exposed to semiconductor demand at the leading-edge, so what TSM has to say regarding chip demand matters a lot as the biggest manufacturer of chips manufactured at the leading edge.

Another issue worth watching is whether ENTG is seeing companies have second thoughts about spending on wafer fab equipment. TSM itself did not change its FY2023 capex budget, but it did say spending would likely come at the lower end of the projected range. ENTG has benefited from chipmakers sticking with the planned construction of new fabs, but it is possible there might be changes with semiconductor demand weaker than anticipated.

The market has given the thumbs up to ENTG selling assets to pay down debt, but the market will also be interested to know if ENTG has any additional ideas as to how to tackle the company's debt. At the end of Q1, gross leverage stood at 5x with gross debt at $5.8B, but ENTG has set a target of reducing gross leverage to 3.5x by the end of 2024. Note that the $5.8B does not include the proceeds from the recent asset sales. In contrast, ENTG has cash and cash equivalents of $709M, so ENTG definitely has some work to do.

Investor takeaways

ENTG might be at a pivotal moment. The stock has rallied thanks to a series of events that addressed several of the issues that investors care about. ENTG is selling assets to raise cash and pay off debt. The FY2023 outlook basically believes the worst has passed with Q2 the bottom. In short, ENTG has done much to help sway investor sentiment towards it.

On the other hand, the stock has looked tired after the major rally in May, although buying interest seems to have prevented the stock from going lower. The stock has gone sideways and a catalyst may be needed to break the stalemate. The Q2 report is thus scheduled to be released at a critical time.

The Q2 report needs to build on what was started in the Q1 report, which could power the stock higher. But if the report falls short of expectations, the path may be clear for the stock to surrender some of its YTD gains. There is therefore a lot riding on next week's Q2 report. A good report can get the stock moving, but so too can a bad report.

I am neutral on ENTG. Recent reports from the likes of TSM suggest chip demand has yet to truly recover from the recent slump. In fact, the report from TSM was a disappointment, especially after expectations got a boost from AI. It's not a given, but it is possible the market might get a letdown after the recent string of good news from ENTG.

Bottom line, ENTG cannot afford a letdown now that the stock is at risk of going lower. Investors might want to watch their steps now that the Q2 report is getting closer. The stock has rallied thanks to all the positive vibe generated in the wake of the Q1 report, but if the Q2 report leaves room to think that some of the excitement has gotten ahead of itself, a correction might be in order. It's easy to get caught on the wrong side of the trade under present conditions, so reducing exposure or getting some protection is warranted.

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