VECO - Veeco Instruments: The Boost From China Is Not Likely To Last

2023-07-13 06:32:10 ET

Summary

• Veeco has posted a strong turnaround, which was powered by better-than-expected earnings, guidance and the need for EUV.
• The numbers from VECO raised optimism, but there is reason to believe VECO may not be doing as well as it appears to be.
• Short interest remains elevated despite the strong rally in VECO stock, suggesting some remain unconvinced.
• VECO can continue to outperform with the assistance from China, but watch out if or when China goes into reverse.

Veeco Instruments (VECO), a supplier of semiconductor process equipment, had a terrific month of May, but the stock has struggled in recent weeks. The stock may be having second thoughts after the strong rally, especially since the stronger-than-expected quarterly results seem to have been the result of an unexpected tailwind that is not likely to be sustainable. Why will be covered next.

The month of May made all the difference

On the surface, VECO has done pretty well with the stock up 29.6% YTD. However, it’s worth noting that as recently as May 4, VECO was down for the year. VECO's struggles were in part the result of weak guidance that drove the stock below support as elaborated on in a previous article . Fortunately for VECO, the stock proceeded to gain about a third in value in the next few weeks. The chart below shows how a turnaround in May shook things up for VECO.

However, the stock has looked tired since then. Note how the stock has been hovering just above $24 recently. Keep in mind that $24 or so also happens to be where the stock peaked in August 2022 before the stock turned south. It looks like the stock is subject to selling pressure, which is probably not so surprising after the rally in the month of May.

It’s therefore worth mentioning that short interest remains elevated despite the recent rally, which suggests a whole bunch of people remain unconvinced VECO is in the clear, the rally notwithstanding. According to data from the Nasdaq, short interest stood at 5,114K shares as of June 15, which translates to a short float of 10.2%. While this is not exceptionally high, it appears there are quite a few people out there who believe the stock price is likely to be heading down in the near future.

Why the stock rallied and why it could be heading down

This belief is not without some merit. The rally in the stock in the month of May did not happen for no particular reason. On the contrary, the rally was made possible by a couple of positive developments for VECO. For instance, VECO got a lift, similar to other semis, when Nvidia ( NVDA ) reported quarterly results and guidance that were much stronger than expected.

NVDA is seeing bumper sales, which is expected to boost demand for GPU chips manufactured using the latest process nodes. These leading-edge nodes rely on EUV, which bodes well for VECO as a supplier of ion beam deposition systems for EUV. Keep in mind that VECO could use some help since it is currently facing the adverse effects from the downturn in the semiconductor market.

It also helped that VECO was trading at relatively low valuations. Valuations have since gone up after the major rally in the stock, but multiples for VECO are about in line with the median in the sector. The table below shows some of the multiples VECO trades at.

Source: SeekingAlpha

However, there was another and arguably more important catalyst in the form of better-than-expected earnings and guidance from VECO. The market was expecting non-GAAP EPS of $0.26, but guidance was much better with non-GAAP EPS expected to come in between $0.26 and $0.34. Guidance also calls for Q2 revenue of $145-165M as shown in the table below. While both represented YoY declines, they add credence to the belief the worst of the downturn is over.

Source: VECO Form 8-K

The Q2 guidance followed Q1 results that were also better than expected. VECO was expected to post non-GAAP EPS of $0.20 on revenue of $142M, but VECO earned $0.30, $0.10 more than expected, on revenue of $153.5M in Q1. The table below shows the numbers for Q1 FY2023, which reveal the extent to which the numbers took a hit from the recent downturn. Note that Q4’s GAAP net income of $128.9M or $2.00 per share was due to a $117M tax benefit.

In addition, VECO expects the numbers to improve in the second half of the year. VECO is projecting non-GAAP EPS of $1.15-1.35 on revenue of $630-670M in FY2023. This after Q2 guidance suggested VECO will earn $0.56-0.64 on revenue of $298.5-318.5M in the first half. In other words, if the latest outlook from VECO is any indication, then the worst of the downturn has passed according to VECO. From the Q1 earnings call:

“Now for some additional color beyond Q2. Based on our current backlog and visibility, we reiterate our 2023 revenue outlook of between $630 million and $670 million, with growth in the second half of the year. We also continue to target diluted non-GAAP EPS for the full year to be between $1.15 and $1.35 per diluted share.”

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

Why China could become a problem for VECO

The quarterly results were much better than expected, suggesting VECO is not as bad off as some may have thought. However, it may be too early to declare the coast is clear for VECO. A closer look at the recent quarterly results suggests why. The stronger-than-expected results from VECO were made possible with a big assist from China.

Source: VECO Form 10-Q

The table above breaks down quarterly revenue by geographic region. Note how China was the outlier. Quarterly revenue may have beaten estimates with a decline of just 1.9%, but that’s with China revenue almost doubling in size from $30.4M to $60.7M. China’s share of total revenue jumped from 19.4% in Q1 FY2022 to 39.6% in Q1 FY2023.

This is much higher than normal. In comparison, China’s share of total revenue was 18% in FY2021 and 19% in FY2022 according to the latest Form 10-K . Without the additional sales to China, the quarterly results could have looked very differently. This helped VECO out in the short term, but it could also be a bad thing down the road.

What may be driving the spike in sales to China

The doubling in sales to China should raise some eyebrows. It is unusual to buy so much more, more than usual, at a time when business conditions are weak and pretty much everyone else is doing the opposite. Such a big increase in such a short amount of time suggests China is not just placing orders to satisfy real demand, but there are other considerations as well.

It may be speculation as only the companies that placed the orders can say for sure, but it’s possible, if not likely, that the reason why China is purchasing twice as much is because Chinese companies are worried they may not have the opportunity to keep buying as they please. Keep in mind that the U.S. government has imposed export controls on the sale of semiconductor manufacturing equipment.

These export controls mainly relate to leading-edge applications and not all equipment is subject to restrictions. However, there are calls to impose more export controls, which would presumably affect equipment that is not currently affected. So to prepare for such an eventuality, China may be trying to get ahead of export controls by ordering more while the opportunity is still there.

On the other hand, this also suggests VECO is not as well off as the quarterly numbers suggest. If or when Chinese demand falls off, whether due to export controls or because China has what it wants, VECO may no longer see the bump in demand that has helped it beat earnings expectations rather handily. The market has bid up the price of the stock recently, but shorts may still be on to something with the above in mind.

Investor takeaways

VECO had a lot of good news to share recently. Both the Q1 results and Q2 guidance were ahead of expectations. The outlook for the second half suggests the worst of the recent downturn has passed and the company is now on the path to recovery. Furthermore, VECO benefited from strong results from NVDA, which suggest demand will get stronger for EUV and related suppliers by extension, including VECO. All this helped power a turnaround in the stock after disappointment earlier in the year. The stock was threading water, but good news led to solid gains for VECO.

However, a look under the hood suggests VECO is not doing as well as the headline numbers suggest it is. If not for a doubling in sales to China, the quarterly results would have looked much worse. The spike in China stands out even more when you consider demand is down due to the slump in the industry and most are cutting back on orders from VECO for that reason.

It’s possible China has a real need for all the extra orders. However, in light of the weak market where demand is down, the more likely reason behind the surge in orders is that companies in China are worried there will be more export controls, which could deprive them of the ability to keep ordering from VECO.

I am neutral on VECO. While the recent results from VECO give rise to optimism, VECO may actually be doing worse than the headline numbers would lead someone to believe. Still, the lift VECO is getting from China could continue for a while, provided no trade restrictions are put in place in the meantime.

Purchases from China could remain elevated, even if they’re not as high as in Q1. But at some point, the surge in orders must come to an end as companies would be sitting on too much equipment that is not yet being utilized. The timing for this is unclear, but VECO is sure to notice if or when there is a change in China due to its fairly large exposure to China.

Bottom line, if China keeps buying stuff at a highly elevated pace, then the quarterly results at VECO should benefit. This could power the stock higher, but if the buying stops for whatever reason, the opposite may happen. So while VECO looks to be in good shape after the recent developments, be aware that not everything is as it seems.

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