MKSI - MKS Instruments: Still Has Lots Of Work To Do

2023-06-19 11:38:08 ET

Summary

• MKS stock has gone up and down all year and, lately, it's been the former for a couple of reasons, including a ransomware event.
• The latest outlook suggests the trough is in after Q1, although growth is expected to remain muted the rest of the way due to headwinds.
• The income statement and the balance sheet have deteriorated due to an acquisition and an industry downturn, but 2024 forecasts are optimistic nonetheless.
• MKSI has a lot more going against it than for it, which could be why some big shareholders have thrown in the towel.

MKS Instruments (MKSI), a provider of technological solutions to the semiconductor, electronic and industrial markets, has ebbed and flowed this year, at least when it comes to the stock. MKSI started out strong with big gains in the first few weeks of 2023, only to give it all back in the following months for a few reasons. The stock has risen again in recent weeks, but it may soon have to overcome a hurdle if it wants to keep going. Why will be covered next.

MKSI has gone up and down

MKSI is up for the year with a gain of 24.1% YTD, but that's not the whole picture. The stock has risen, but it has also shown gains can be lost just as well. The stock started 2023 strong with a gain of 34.7% after it reached an intraday and 2023 high of $114.15 on February 2. But MKSI could not keep it up and the stock proceeded to lose it all in the following months.

However, the stock has made a comeback in recent weeks and it is on pace to close in on the February 2 high. The question then becomes whether the stock can keep going like it has in recent weeks or if it will reverse course like it did before. It's therefore worth mentioning that the previous rally did not end on February 2 for no particular reason.

On the contrary, there may have been more than one reason. There was of course the ransomware event , which MKSI became aware of on February 3. This event is expected to negatively affect earnings, although the impact is not expected to be permanent. In addition, there may have been another factor that contributed to the decline in the stock.

Note the decline in the stock following the February 2 high. The decline was halted when the stock came into contact with the lower ascending trendline shown in the chart above. This trendline extends all the way back to November 9, 2022, which is when the stock hit an intraday and 52-weeks low of $64.77. This date also marked the end of a long downtrend in the stock, which started in April 2021 after the stock topped out at $199.44.

In addition, with this move down, the stock completed a 100% Fibonacci retracement of the prior uptrend, which started with the March 2020 low of $66.87 and ended with the April 2021 high of $199.94 mentioned before. If we now assume the rally off of the November 9 low is a retracement of the previous downtrend, then the 38.2% retracement level of this downtrend, starting from the April 2021 high at $199.94 to the November 2022 low at $64.77, is $116.21. This is close to the February 2 high of $114.15.

What this suggests is that part of the reason why the stock topped out at $114.15 on February 2 is because resistance was nearby. This also suggests that while the stock, which closed at $105.18 on June 16, can move higher, it's likely to encounter resistance once it gets near the February high. The stock may even go for a repeat by turning south once more like it did back in February and in line with recent trading patterns.

Why MKSI has ebbed and flowed

As mentioned previously, MKSI has gone up and down this year and even before that. This is to be expected for a stock that is facing elevated levels of uncertainty on several fronts. The industry is currently in a downturn, which came at a bad time for MKSI since it went into debt to acquire Atotech , but there's also the ransomware event, all of which add uncertainty to the quarterly numbers. For instance, the stock fell in February after it became clear earnings would take a major hit from the ransomware event.

The stock rose after the most recent earnings report, the first since the ransomware event, came in better than expected. The quarterly numbers still took a big hit, but the impact was not as bad as perhaps feared by some. Q1 revenue actually surpassed estimates with an increase of 7% YoY, although it still decreased by 26.8% QoQ to $794M.

Keep in mind that unlike Q4 FY2022 and Q1 FY2023 which include contributions from the Atotech acquisition, Q1 FY2022 does not as it preceded the acquisition, something that is skewing the quarterly comparisons. Nevertheless, non-GAAP EPS surpassed estimates by as much as $0.66 with $0.48, a decline of 82.3% YoY. Still, MKSI ended with a GAAP loss of $42M or $0.64 per share.

The main difference between the GAAP and non-GAAP number is amortization of intangible assets to the tune of $81M, which is included in the former, but excluded in the latter. Adjusted EBITDA was $142M in Q1 FY2023, down from $282M in Q4 FY2022 and $211M in Q1 FY2022. The table below shows the numbers for Q1 FY2023.

Source: MKSI Form 8-K

The Atotech acquisition cost MKSI $16.20 in cash and 0.0552 share of MKSI stock for every share of Atotech, which explains the YoY jump in share count. It also explains why total debt currently stands at $5.1B, partially offset by cash and cash equivalents of $880M on the balance sheet. In comparison, MKSI was essentially debt-free with more cash than debt before the Atotech acquisition. This has consequences. Interest expense, for instance, soared to a hefty $82M in Q1, up from just $6M a year ago.

Guidance calls for Q2 FY2023 revenue of $930-1,030M, an increase of 23.4% QoQ and 28.1% YoY at the midpoint. Keep in mind that Q2 FY2022, unlike Q2 FY2023, did not benefit from Atotech contributions. The forecast expects non-GAAP EPS of $0.84-1.42, which is better QoQ, but also less than last year's $2.59. Adjusted EBITDA is seen at $196-250M, which is more than last year's $208M at the high end, but remember that EBITDA does not include things like the interest MKSI has to pay on debt.

Note that the Q2 number includes revenue that was deferred in Q1 due to the ransomware issue.

"We estimate the ransomware incident impacted our semiconductor revenue by approximately $110 million in the first quarter. Excluding the impact of the ransomware incident, we estimate semiconductor revenue was down approximately 17% sequentially and 14% year-over-year. We expect to make up approximately 75% of that delayed revenue in the second quarter and virtually all the remaining balance made up in the third quarter."

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

Guidance did not extend beyond Q2, but MKSI did give out hints as to what to expect in H2.

"In summary, while the year got off to an unexpected start, we have rebounded well operationally and are delivering affected shipments to customers. We're also building early momentum with customers for our optimized the interconnect offering. Overall business levels have softened entering the second quarter, but we remain optimistic about the quarters to come. We expect MKS' total revenue in the second half of 2023 to be slightly higher than the first half levels, driven by a modest improvement across each of our three end markets."

While MKSI acknowledges business has softened, it still believes H2 will show growth, if only by a modest amount.

Earnings estimates have been revised in line with the above. Consensus estimates expect non-GAAP EPS of $1.18 on revenue of $985M in Q2, which, when added together with the Q1 results, implies EPS of $1.66 on revenue of $1,779M in H1. These numbers are projected to get slightly better in H2, resulting in non-GAAP EPS of $3.45 on revenue of $3.66B at the end of FY2023.

In comparison, MKSI earned $9.97 on revenue of $3,547M in FY2022 and $11.38 on revenue of $2,950M in FY2021. Remember, much of this predates the Atotech acquisition. However, estimates predict MKSI will recover to a certain extent the following year with non-GAAP EPS of $4.85-6.71 on revenue of $3.91-4.23B in FY2024. At the high end of $6.71, this would give MKSI a P/E ratio of 15.7 with a stock price of $105.18.

These projections are based on an expected recovery in the wafer fab equipment or WFE market. For instance, a recent report from SEMI predicts the WFE market will expand by 11% YoY in 2024, a year after the market is expected to contract by 20% YoY to $79B in 2023. MKSI is expected to benefit from this.

MKSI comes at a premium

On the other hand, valuations may be an issue for some. For instance, MKSI trades at 30.5 times forward non-GAAP earnings with a trailing P/E of 13.5. Keep in mind earnings are expected to shrink in the next 12 months compared to the prior 12 months, which is why the former multiple is much higher than the latter.

To put this in perspective, the median in the sector are 22.7x and 18.5x respectively. The GAAP numbers are even higher, because the non-GAAP numbers do not include certain charges, including ones related to the Atotech acquisition. The EBITDA ones look better, but that's because they exclude interest payments, which MKSI will be paying for years to come.

Source: SeekingAlpha

Investor takeaways

MKSI has done better in recent weeks, thanks to further clarity on the ransomware issue. The impact was not as bad as feared and most of the losses will be recouped soon enough. Q1 is seen to be the trough and the numbers are expected to get better in H2, if only by a little bit. However, while the ransomware issue has been dealt with, there are other issues that will continue to keep MKSI occupied, maybe even for years.

The industry is currently in a slump, but forward projections have priced in a strong rebound in 2024. Yet there is little evidence at this time to support the notion of a double-digit rebound in the WFE market. On the contrary, MKSI reported seeing a softening in business in its most recent report. If 2024 turns out to be more like what MKSI expects from H2 2023, which is very modest growth, then MKSI looks expensive with multiples where they are.

Little to no growth would also have negative implications for MKSI's debt on the balance sheet. MKSI picked a bad time to leverage itself just when the downturn in the WFE market hit. GAAP earnings, which some consider the only real indicator of profitability for a company, is unlikely to get back to the record high of $9.90 in FY2021 anytime soon, and that's with the addition of Atotech. The stock is likely to continue to do what it has done all year and really before that. That is to rally, followed by selloffs just as large. The stock has rallied recently, which suggests a selloff may not be so far away.

I am neutral on MKSI as stated in a previous article . There is a reason why a number of MKSI shareholders put two million shares up for sale recently. MKSI has some things going for it, but it also has a lot more things going against it. Both the income statement and the balance sheet, for instance, need major work. Work that is likely to take a long time to get done, possibly even years. Long MKSI will have its day in the sun, but today is not that day.

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