TER - Teradyne: Lack Of Visibility Info For FY24 Is A Big Overhang

2023-08-04 01:34:56 ET

Summary

• Teradyne's 2Q23 revenue exceeded expectations, driven by gains in the Semiconductor and Systems Test segments.
• Lack of visibility for FY24, particularly in mobile SoC testing, is a major concern for the stock.
• In the long term, TER has potential growth opportunities in the Compute Test market and the HBM DRAM market.

Summary

Teradyne ( TER ) designs, manufactures, sells, and supports semiconductor test products and services. Following my coverage on TER, which I recommended a hold rating due to my concern about the full extent of the recovery, which depends heavily on the strength of SOC revenues and end markets like smartphones and computers. Valuation was not cheap either, relative to history.

This post is to provide an update on my thoughts on the business and stock. I am reiterating a hold rating as my concern regarding the lack of visibility (particularly for FY24) has not been addressed in the recent call. In fact, management’s lack of confidence has led me to further shun the stock. The high valuation multiple of TER is also a major concern.

Investment thesis

TER's 2Q23 revenue of $684 million surpassed the consensus estimate of $655 million, driven by gains in the Semiconductor and Systems Test segments while Industrial Automation and Robotics performed poorly. The impressive 58.8% gross margin is in line with the company's long-term target range of 59%-60%. It was definitely positive to see gross margin trending towards the right direction. I emphasize, however, that the main cause was a delay in promptly accounting for expenses caused by initiatives to strengthen the supply chain. As such, I would refrain from being overly positive about this improvement. The company's operating margin was 22.1%, and its earnings per share of $0.79 beat expectations of $0.65.

The lack of insight into mobile SoC testing in 2024 is a major issue with TER. Management was hesitant to lay out any early thoughts around 2024 because the mobility market is still stagnant. I don't think the market can accurately model FY24 mobile SoC test performance based on the information management has provided. Specifically, management mentioned that the company is well positioned for a comeback thanks to the combination of strong growth in certain areas like Autos and Compute, and an anticipated volume recovery in smartphones. The latter doesn't help at all, as I believe most investors expect some form of recovery, at some point. What I believe investors are most interested in hearing about is the timing and magnitude of a recovery at TER's largest Mobile SoC customer, such as Apple. While it is likely that Apple will increase its spending on testing in 2024, it is tough to estimate by how much. Too many unknowns, such as the total number of smartphones sold, the degree of complexity of the design, and the timing of the product's release, can affect the amount spent. I believe this lack of visibility will continue to be an overhang on the stock price.

On the other hand, I took heart from the 2Q23 results call because it highlighted two intriguing long-term growth catalysts.

First, TER has an alluring opportunity to join the rapidly growing Compute Test market thanks to the popularity of Vertically Integrated Producers like cloud hyperscalers. It highly likely that revenue from these clients will fall this year due to a high base in 2022, but I remain optimistic about the market's long-term potential, especially as more businesses take charge of chip design to differentiate themselves.

Second, the HBM DRAM market presents a substantial AI opportunity. Demand for HBM and DDR5 testing has prompted management to highlight the potential benefits of investing in Cloud AI. I expect that the demand for TER's services will increase thanks to the positive impact that AI investments will have on the development of next-generation flash memory architectures.

Valuation

I believe the fair value for TER based on my model is $107.80. My model assumptions assume a 15% decline in FY23, as I expect YTD weakness to continue. As for FY24, while management has guided for $4.6 billion to $5.25 billion in 2Q22 earnings, I am modeling a much lower revenue figure given the weakness so far and also the lack of confidence in management commentary in the 2Q23 call. That said, I expect margin to recover back in line with historical range.

Peers include: Aehr Test Systems, FormFactor, Entegris, Allergro MicroSystems, Onto Innovation, Axcelis Technologies, MKS Instruments, Applied Materials, Cohu, and Amkor Technology. The median forward PE multiple peers are trading at is 28x, and the expected 1Y growth rate is 5%. I believe the re-rating of the industry has driven TER's valuation to near its 10-year high of 28x, and I don’t see this as sustainable given the expected growth rates (i.e. I think capital will flow to other industries that are growing faster/similar at a cheaper multiple). Specifically for TER, the lack of FY24 visibility also casts further doubt on management’s ability to achieve their FY24 guide. I expect valuation to rerate to the pre-Covid average of 19x.

Conclusion

I reiterate a hold rating on the stock. While the company's 2Q23 results showed positive revenue and gross margin trends, the lack of visibility for FY24, particularly in mobile SoC testing, remains a significant concern. Uncertainty surrounding TER's largest Mobile SoC customer and the timing and magnitude of a recovery in that segment continue to be an overhang on the stock price.

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