MKSI - MKS Instruments Is Still In Consolidation Mode

2023-09-11 15:10:12 ET

Summary

• The stock has undergone another reversal this year with the most recent one ceding most of the gains from earlier in the year.
• MKSI has traded sideways all year and the latest charts suggest the stock is currently hemmed in between support and resistance.
• The income statement and the balance sheet are undergoing change for various reasons, all of which are worth mentioning.
• I think the stock is likely to continue to head sideways for several reasons, which means staying put makes a lot of sense.

MKS Instruments ( MKSI ), a provider of technological solutions to the semiconductor, electronic and industrial markets, has seen its stock falter in recent weeks. This after the stock rallied for a couple of months, resulting in a gain of as much as 38.7% at one point in June. MKSI has see-sawed all year and there is reason to believe this could continue for some time. Why will be covered next.

MKSI has reversed course once again

A previous article from late June concluded that even though the stock was on fire at that time, MKSI still had a lot of work to do, including reducing the large debt load with the semiconductor industry in a slump, which is among the reasons why the stock was rated a hold. This proved to be warranted because the stock has since reversed course to give back most of its 2023 gains with most of the losses coming in the wake of the Q2 report.

The stock is still up 9.2% YTD after closing at $92.50 on September 8 as shown in the chart above. The chart shows how the stock has essentially moved sideways in 2023, despite all the big moves up and down. The stock’s price of $92.50 is actually very close to where it traded a year ago in September 2022. In other words, anyone who has held the stock during this time has essentially nothing to show for the last 12 months.

Furthermore, if the 2023 lows and the highs are connected by trendlines, then it can be observed how the lows are trending higher and the highs are trending lower. The two trendlines are on pace to converge, although not anytime soon, which suggests the stock could continue to move sideways for some time to come with the stock moving between the trendlines. The stock is essentially consolidating.

Nevertheless, the stock is currently just above the lower trendline, which can be both a good thing or a bad thing. Note that the stock came very close to the trendline at the lows on September 8, but it backed off before the end of the day. On the one hand, it’s encouraging to see the stock did not fall below the trendline, which means the trend of higher lows remains intact. On the other hand, if the stock were to break through the trendline, the stock could potentially make its way back to the 2023 lows, if not lower.

Note how the stock spent weeks in the $79-81 region in late April/early May after a long decline, before starting its rally in May/June. All the 2023 lows can be found in this time period, including the 2023 low of $79.63 set on April 26, a week after hitting $79.68 on April 19. It’s also the same region where the stock spent a lot of time in late 2022 as shown in the previous chart.

This repeated bottoming of the stock in the $70-81 region, give or take a few dollars, is an indication that support exists within this region. So if the stock does not manage to stay above the lower trendline and falls below it, the stock could potentially lose 12.4-14.6% before a rebound is likely in the $79-81 region. But for now, the trendlines remain intact and the stock is likely to keep doing what it has essentially done all year, which is to trade sideways.

What triggered the latest reversal in the stock

The chart makes it clear the stock has experienced several ups and downs in 2023. The latest reversal coincided with the Q2 report, which was a mixed bag. On the one hand, MKSI surpassed estimates for quarterly earnings, at least in terms of non-GAAP, but, on the other hand, guidance was soft and write-downs due to unfavorable market conditions were huge. The table below shows guidance for Q3 FY2023.

Source: MKSI Form 8-K

The table above shows the preceding quarters in comparison. In addition, there are a few things worth mentioning to put the numbers in proper context. First, MKSI acquired Atotech in August 2022, which means Q2 FY2022 predates the Atotech acquisition and thus did not benefit from Atotech contributions like the other quarters did.

Q1 FY2023 was negatively affected by a ransomware event, which caused revenue to be pushed out into the following quarters, resulting in big QoQ gains in Q2 FY2023. On the other hand, the GAAP numbers in Q2 FY2023 were negatively impacted by goodwill and intangible asset impairments to the tune of $1,827M, which led to a GAAP loss of $1,769M or $26.47 per share. These rather large impairments were mainly the result of weak industry conditions. From the Q2 earnings call:

“I'd like to touch upon the noncash, goodwill and intangibles impairment charges in the quarter, which totaled $1.8 billion associated with our Materials Solutions division, which represents the former Atotech business and our Equipment Solutions business, which represents the former Electro-Scientific Industries business.

The current market environment, particularly the softer demand in the PC and smartphone markets is the primary driver of both write-downs with higher market interest rates playing significant role in the Atotech impairment analysis as well.”

A transcript of the Q2 FY2023 earnings call can be found here .

In terms of non-GAAP, which excludes the aforementioned impairments, Q2 FY2023 net income was $88M or $1.32 per share. Adjusted EBITDA was $254M, up QoQ and YoY, but keep in mind that this number excludes, among other things, interest payments on debt, which is quite substantial in the case of MKSI due to the acquisition of Atotech.

Net interest expense totaled $79M in Q2 FY2023, up from $6M in Q2 FY2022. The Atotech acquisition was financed with debt and by issuing stock, which explains why the weighed-average number of shares jumped YoY. Speaking of debt, total debt amounted to $5.1B, partially offset by $758M in cash, cash equivalents and short-term investments.

Why MKSI may be below from fair value, but with a caveat

The above makes it clear the income statement and the balance sheet at MKSI could use some improvement, something that is likely to weigh on people’s minds when they decide whether MKSI is a buy or not. Recall how some large investors decided to help out MKSI in June to the tune of two million shares.

Still, an argument can be made that the stock is trading below fair value. MKSI has made a number of acquisitions in recent years, which has given growth a boost. For instance, MKSI achieved revenue of $3,547M in FY2022, a year in which it posted non-GAAP EPS of $9.96, but this includes partial contributions from Atotech. The year before that, when Atotech was not around, revenue was $2,950M in FY2021, but MKSI has stated during prior presentations that FY2021 revenue would have been more like around $4.4B on a pro forma basis with Atotech included.

“Thinking about our business in the second half of 2023, we continue to expect MKS' total revenue in the second half to be slightly higher than first half levels”

H1 FY2023 revenue was $1,797M, which could increase to $2,677-2,777M after three quarters based on Q3 guidance. FY2023 revenue is thus projected to end up around $3.65B, based on MKSI’s suggestion at the Q2 earnings call that H2 FY2023 revenue will be slightly higher compared to H1 FY2023. With revenue of $3.65B, non-GAAP EPS is projected to end up around $3.85. This translates to a non-GAAP P/E ratio of 24 with stock price of $92.50. It's also way less than the $9.96 the year before and that’s with the full addition of Atotech.

However, at the 2022 Analyst Day Presentation , MKSI believed that revenue of $5.6B and non-GAAP EPS of $13, or better, would be achievable by FY2027 according to its long-term model with FY2021 as the baseline. This implies revenue growing at a CAGR of about 5% in FY2022-2027 using pro forma FY2021 revenue of $4.4B. Similarly, non-GAAP EPS would need to grow at a CAGR of about 10%. Assuming earnings do grow 10% on average until FY2027 and using a baseline EPS of $11.38, a fair value for MKSI would be around $113. Interestingly, this could help explain why all the 2023 peaks for the stock are in the $110-115 region.

With that said, it’s worth mentioning that the aforementioned numbers are based on MKSI projections from late last year. MKSI has not updated its model, but market conditions have deteriorated substantially since then as a result of weak demand, including for semiconductors. It’s possible MKSI may have to lower its forward projections, which could in turn possibly lower the fair value for MKSI, which is highly subjective to begin with.

Investor takeaways

I remain neutral on MKSI as nothing much has happened to warrant a change. If anything, the stock has traded within a range all year, which proved neutral was the right call. There seems to be support for the stock in the $79-81 region, or around that ballpark, and there seems to be resistance in the $110-115 region. Fair value for MKSI seems to be around $113, although this number is based on old projections that may be outdated, especially with worse-than-expected conditions in the semiconductor industry.

If the trendlines are any indication, then the stock is likely to continue heading sideways. There is a small chance the stock could break the lower trendline, but even if that were to happen, a rebound is likely if it gets close to $80 or so. This sideways action is unlikely to be broken if the quarterly numbers remain flattish as the near-term outlook from MKSI suggests.

Continued sideways action is also likely with MKSI not having much leeway in the form of capital returns due to the state of the balance sheet. MKSI has over $4B of net debt to take care of first, which will take several years at least if MKSI maintains its quarterly run rate of roughly $250M for adjusted EBITDA.

Bottom line, continued sideways action is likely for several reasons, including flattish near-term growth, resistance and support blocking the stock and general uncertainty about where the industry is heading during the current downturn. After all, there is a reason why two million shares were put up for sale recently due to big shareholders appearing to throw in the towel.

MKSI might have a brighter future down the line, but in the near term, there is too much weighing down on MKSI for the stock to do well on a sustained basis in my view. It’s possible for the stock to rally for a while, only for it to reverse course to head in the other direction, which is pretty much what MKSI has done in 2023. This can change, but the stock’s track record all year says it likely won’t anytime soon.

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