VECO - Veeco Instruments: The Beneficiary Of Fortunate Circumstances

2023-12-09 06:45:48 ET

Summary

• VECO has outperformed by growing instead of contracting like many in the industry and the stock has posted strong gains in 2023.
• While VECO may appear to be in a good position with 2023 coming to an end, a closer look suggests all may not be so well.
• Shorts seem to be drawn to VECO, far more than seems warranted at first, which raises the question what is motivating the shorts.
• Long VECO makes a lot of sense in some ways, especially with how the stock has soared higher, but the case is actually not as clear cut.

There are a few weeks left, but 2023 has turned out to be a good year for Veeco Instruments ( VECO ) with strong gains for the stock after a very slow start. However, for several months, it looked like the stock was intent on ending 2023 on a weak note by heading down after a major rally. Only this did not happen in the end. The stock recovered starting in November and it is now close to the highs for the year. Why will be covered next.

The stock recovers from a bout of weakness

A previous article from last September rated VECO a hold even though the stock was in the midst of a slide that had already lasted a couple of months because of the potential presence of support close by, which was likely to limit further downside. In addition, the article urged caution towards VECO because there was reason to believe recent quarterly earnings may have benefited from the pulling forward of demand, particularly in China.

As it happened, VECO did go on to stabilize in the following weeks, but the stock market selloff triggered by the outbreak of violence in Israel in mid-October conspired to take down the stock once more. However, the situation in the Middle East has not escalated like some feared it might, which helped trigger a recovery in the stock market. VECO too saw its stock bounce starting in November along with other stocks.

The chart above shows how the stock has gained 53.1% YTD in 2023, although with a fair amount of volatility. Note how the stock seems to be having problems going higher in the $28-32 region. The rebound in November topped out at $29.55 on November 22, which is in the same $28-32 region where the stock topped out back in August. The highest the stock got was $31.09 on August 10, which happens to be the 2023 and 52-weeks high for VECO.

Why resistance may not be far away for VECO

The stock was stopped more than once in the same region, which indicates there is probably resistance at or around the $28-32 region. This is unlikely to be for no particular reason. A review of Wall Street analysts covering VECO show their price targets are in the $28-37 range. The midpoint is $32.50, just above the aforementioned $28-32 region. This could help explain why the stock has been having problems going higher because much higher would put the stock way past most price targets for VECO.

Fair value is subjective, but at least one method used to calculate fair value suggests it can be found in the $28-32 region. For instance, if we assume VECO manages to grow earnings by 20% on average per year for the next five years and with TTM non-GAAP EPS of $1.57, then this suggests fair value for VECO is around $31.40, not far from the 52-weeks high. The discounted cash flow method also points to the low thirties where fair value can be found.

How VECO has benefited from AI

There is another thing worth mentioning. Note how in the previous chart the stock did not do all that well if May-August is excluded. In fact, while the stock is now sitting on strong YTD gains of 50+%, as recently as early May, VECO was actually down for the year. It took a major rally from May through August to shake things up out of their slumber. All the YTD gains can be attributed to this rally.

The rally was enabled by the euphoria surrounding AI in the wake of blowout earnings from the likes of Nvidia ( NVDA ) in May. This caused investors to seek out potential beneficiaries of the rise of AI and VECO fit the bill as a supplier of various equipment needed to produce AI chips, including deposition systems to manufacture EUV masks and laser annealing systems to manufacture HBM memory.

Still, the AI-induced rally has petered out for many. NVDA, for instance, has been essentially range-bound since August after a powerful rally. VECO too has seen the rally in the stock come to a standstill with no new highs since August. It's been essentially sideways with the stock now where it was back in mid-August.

The stock did drop in mid-October along with the stock market as a whole due to the outbreak of hostilities in Israel, but the stock market recovered and so too did VECO in November. Adding to the bounce in November was the most recent earnings report, which sailed past estimates for the top line and the bottom line in particular.

VECO surprises to the upside

The consensus was that VECO would report non-GAAP EPS of $0.37 on revenue of $168M, but VECO actually earned $0.53 on revenue of $177.4M. The table below shows the numbers for Q3 FY2023. Note that the hefty GAAP loss of $1.61 per share in Q2 FY2023 was due to the refinancing of convertible notes.

Source: VECO Form 8-K

Guidance calls for Q4 FY2023 revenue of $155-175M, an increase of 7.3% YoY at the midpoint. The forecast expects GAAP EPS of $0.22-0.33, a decline of 85.3% YoY at the midpoint, and non-GAAP EPS of $0.35-0.45, an increase of 5.3% YoY at the midpoint. Note that the GAAP numbers in Q4 FY2022 benefited from a tax benefit to the tune of $117M, skewing the YoY comparisons.

Source: VECO Form 8-K

In light of the latest numbers, VECO raised its FY2023 outlook. FY2023 revenue is projected to come in at $648-668M, up from the prior $630-670M. FY2023 EPS is expected to come in at $1.55-1.65. Q1 FY2024 is seen to be similar compared to the two preceding quarters. From the Q3 earnings call:

"Based on our year-to-date results and our fourth quarter guide, our full year 2023 revenue guidance is now $648 million to $668 million tightened and increased from our prior range of $630 million to $670 million. Moreover, we are again raising our profitability outlook for the year to account for higher revenue, stronger gross margin, and lower tax rate. We now expect non-GAAP EPS between $1.55 and $1.65 per diluted share. And for some additional color beyond Q4, based on market conditions and our visibility, Q1 2024 revenue is looking to be in a similar range to quarterly revenue in the second half of 2023."

A transcript of the Q3 FY2023 earnings call can be found here .

In comparison, VECO earned $1.57 on revenue of $646.1M in FY2022. VECO will thus end FY2023 with positive growth, albeit a very modest amount, which is more than what others can say. The semiconductor industry as a whole is expected to end 2023 will sales contracting in the low teens YoY.

Why shorts are interested in VECO

On the surface VECO does not appear to fit the profile of the kind of stock shorts would be interested in. VECO does not seem to have any traits that shorts would be interested in. For instance, both the income statement and the balance sheet do not show anything worrisome. Demand is holding up and 2024 is not forecast to be any worse. The stock has gained a lot in 2023, but multiples are not unreasonably high as shown in the table below.

Source: Seeking Alpha

Yet, while short interest in VECO is not screaming high like some other stocks, short interest at 10.7% of the share float is significantly higher than most stocks, especially for a stock that does not appear to have any obvious flaws like persistent losses or a weak balance sheet. Short interest of 5,896K or 10.7% is an indication that for whatever reason there is a fair amount of pessimism directed towards VECO.

A significant amount of people seem to believe the stock is destined to head lower and are therefore shorting it, even though VECO seems to have much in its favor. It is not possible to know the motivation behind every short out there, but one possible explanation is if there is the belief the quarterly numbers will deteriorate, more than is believed possible.

There is reason to believe this could happen. As mentioned earlier, VECO may have been the beneficiary of the pulling forward of orders in China, which would have made recent quarterly earnings look better than they otherwise would have been. In recent years, China has accounted for around a fifth of revenue at VECO. For instance, China contributed 19% in FY2022 and 18% in FY2021 according to the most recent Form 10-K .

In contrast, China's contribution is expected to come in the high 30% range in Q4 FY2023, or about double the number in FY2022 and FY2021.

"So yeah, we expect in the high 30% range of revenue in the fourth quarter coming from customers in China."

VECO might grow in 2023, unlike most in the industry, but the table below shows that if not for bumper sales in China, VECO would have contracted in 2023. China sales grew by 59.4% YoY in the first three quarters of FY2023, but that was very much the outlier. Most other regions saw sales shrink, which raises the question why China is going against the tide.

Source: VECO Form 10-Q

In light of the current trade environment, which has seen the U.S. government impose increasingly stringent trade restrictions on companies in China, the latest coming in October, the most likely explanation is that VECO's customers in China are rushing to get their orders in while they still have the opportunity since they may no longer be able to do so in the future. In other words, real demand may be significantly less than the headline numbers say it is.

Investor takeaways

VECO has done what most in the semiconductor industry have not been able to do in 2023, which is to show positive growth, and the stock has gained 50+% in 2023, but I am nonetheless neutral on VECO. There is reason to believe VECO was and continues to be the beneficiary of trade distortions brought about by government intervention in the market, which has skewed the quarterly numbers in a way that distorts how well VECO is doing in actuality.

The trade restrictions have caused demand to be pulled forward in China because companies have reason to think they have to order as much and as quickly as possible while they still can. The result is that while VECO has outperformed in 2023, real demand is very likely less than what it appears to be based on recent quarterly figures. So while VECO has posted good results in what has been a challenging year, the numbers need to be treated with some skepticism.

VECO has also been the beneficiary of the euphoria surrounding AI. If not for AI, the stock would likely not have gained as much as it has in 2023. At the same time, while AI remains, the stock is likely near resistance, which could make further gains difficult in the immediate future. Account for these issues and there are definitely reasons to be cautious of VECO at this point.

So while it may be tempting to be long, certainly after the strong gains the stock has posted in 2023, along with other attractive attributes like reasonable valuations, the case for long VECO is not as clear cut as it might seem at first. VECO has benefited from a couple of tailwinds in 2023 that could continue in the short term, but it is doubtful they will remain indefinitely.

China is unlikely to keep ordering as much as they have. The AI euphoria could also fizzle out, especially if relevant players do not show much benefit from AI or as much as expected. If either or both happen, VECO could see its stock surrender some or all of the big gains in recent quarters. It may not happen right away, but it is a possibility that cannot be ruled out.

Those willing to play the odds can bet on VECO outperforming with China and AI providing a boost, which could power the stock higher. Just remember there is a reason why shorts have placed their bets on lower stock prices for VECO. If things go their way, the shorts may be proven right in the end.

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