WOLF - Wolfspeed Shows Some Progress

2023-11-01 05:17:11 ET

Summary

• Wolfspeed's FQ1 results showed the company's Mohawk Valley facility making some progress ramping up.
• Margins continue to be hurt by the Mohawk Valley ramp-up, but should improve dramatically as utilization increases.
• The stock has strong design-ins and should benefit from increased silicon carbide demand in the future.

Back in May , I upgraded Wolfspeed (WOLF) to "Buy" and reiterated that call in August after an accounting change spooked investors. The stock was surging on Halloween following its fiscal Q1 results, although still down after my upgrade. Let's catch up on the name.

Company Profile

As a quick reminder, WOLF designs and manufactures Silicon Carbide ((SIC)) power devices that are used in the electric vehicle ((EV)) and solar industries. There has been a shift toward SiC power devices in certain applications, especially with EVs, as it has superior thermal conductivity versus traditional silicon.

The company also designs and manufactures GaN RF devices, which help improve efficiency, bandwidth and frequency of operations. These devices are often incorporated in telecom infrastructure, military, and commercial applications. WOLF is currently in the process of selling this business to MACOM ( MTSI ).

Fiscal Q1 Results

For the quarter, the company reported a 4% increase in revenue from $189.4 million a year ago to $197.4 million. Analysts were looking for revenue of $197.8 million. The company generated $4 million in revenue from its Mohawk Valley plant, which continues to slowly ramp up.

WOLF recorded adjusted EPS of -53 cents, topping the consensus by 65 cents. Adjusted earnings were a loss of -24 cents the prior-year period.

Gross margins came in at 12.5% versus 35.7% a year ago. Adjusted gross margins, which exclude stock comp, were 15.6%. Gross margins were negatively impacted by an earlier accounting change. As a reminder, last quarter WOLF was no longer able to categorize start-up costs associated with Mohawk Valley as other expenses. Underutilization costs from the facility as it ramps up are now part of cost of goods sold, negatively impacting gross margins.

WOLF had -$112.7 million in operating cash flow from continuing operations in the quarter. Free cash flow was an outflow of -$516.4 million. It ended the quarter with $3.35 billion in cash and short-term investments. It had $3.0 billion in convertible notes and $2.13 billion in other long-term debt.

The company had $2.2 billion of design-in in the quarter. It also had a record of $1.4 billion in device design wins. It said most of these projects were in the automotive space and that many were converting sooner than expected.

WOLF's quarterly results were once again highlighted by continued strong design-in wins. The company is doing a nice job on this front, which should bode well for the future.

Margins remain an issue due to the ramp-up issues at Mohawk Valley, although the company did show some progress ramping up production. However, it's just been a slow process. The good news is it didn't see any new setbacks, as this is the most important part of the WOLF story for the immediate future.

Outlook

For fiscal Q2 2024, WOLF guided for revenue of between $192-$222 million. This include $10-15 million in revenue from Mohawk Valley versus $4 million in FQ1. It noted there will be some softer industrial demand coming from the industrial sector, primarily in Asia.

WOLF sees adjusted gross margins falling between 12-20%. For Q2, the company expects to see -$35 million, or -1,700 basis points, of underutilization costs.

It forecast adjusted EPS to be a loss of between -56 cents to -70 cents. The company announced in August that it was selling its RF business MTSI for $75 million in cash and $50 million worth of MTSI shares. All results from that business have been classified as discontinued operations.

The company also reiterated its forecast that Mohawk would reach 20% utilization by June.

Discussing Mohawk Valley on its Q3 earnings call , CEO Gregg Lowe said:

"Turning to Mohawk Valley, where we continued to ramp production. This quarter, we generated $4 million in revenue from the fab, which compares to $1 million that was delivered in the previous quarter. In the coming quarter, we expect to more than double the output from the fab as we continue to ramp device production. Because of the complex nature of silicon carbide technology, as we ramp the fab further, we are collaborating even more closely with our tool vendors to ensure maximum uptime, the best yields and the most efficient use of all of our tools. We've worked closely with them to develop optimal operating protocols. And as a result, we're seeing good improvement in the fab. I was just up in the fab last week, meeting with the leadership team, walking the floor to talk with our technicians and seeing the progress firsthand that we're making in some of our bottleneck areas. We've now doubled the number of products qualified in the last 90 days, and all of those MOSFETs achieved qualification on the first pass through of the fab, which is a strong indication of the underlying capability of the fab. Finally, those products we have already qualified have sufficient demand to more than satisfy our short-term 20% utilization target. … As I mentioned, we are ahead of plan in our ramp of Building 10 crystal growth for 200-millimeter substrates. By the end of this quarter, we will be producing enough material to support 15% utilization at Mohawk Valley, putting us nicely on track for our goal of 20% utilization by June of 2024."

Ramping up Mohawk Valley remains the most important part of the WOLF story. It certainly isn't happening fast, as evidenced by its goal to get to 20% utilization by the June quarter. However, it also looks like it is on track, which is a positive.

Once at 20% utilization, the facility should generate about $100 million in quarter revenue, albeit on a slight lag between production and shipments. Meanwhile, as utilization increases so will margins, with 30-40% utilization getting the fab to around cash breakeven. However, it has a long way to go, and it ideally wants utilization close to 100%, where it is projected the facility would generate around $2 billion in revenue and $1.2 billion in cash.

Valuation

Re-calculating my prior work, if WOLF can generate $4 billion in revenue at 45% gross margin in 2027, it would generate $1.8 billion in gross profits. Adding back $4 billion future CapEx spending to its EV, that would put it at 5.2x FY27 gross profits. Estimating out expenses minus D&A ($650 million), maybe it can do $850 million in FY27 EBITDA, so it's trading at about 11x FY27 EBITDA.

The company for its part had been looking for even more margin expansion and lower operating expenses to get to 45% adjusted EBITDA margins. That would put its valuation at 5.2x EBITDA, which would be fairly attractive.

Given its struggles ramping up production at Mohawk Valley, I think it is likely that the FY27 outlook it published on Halloween 2022 will likely get pushed back some. It is also selling its RF business, although that was only $400 million in revenue of its projected $4 billion.

Conclusion

WOLF showed that its Mohawk Valley facility is making progress ramping up, although it continues to be slow. The hope is that it will be able to take these learnings and apply them to future new-build facilities so it does not have the same issues in the future. The silicon carbide market continues to have a strong growth trajectory ahead in the EV space, despite some near-term softness from European automakers.

WOLF has a lot of design-ins, now it just needs to get its production on track to meet future projected demand. With strong utilization will come much stronger gross margins, but it still needs to prove that it can execute. It showed progress this quarter, but the bar and time table it is on isn't exactly super demanding.

Overall, I continue to rate WOLF a "Buy." However, the company still has a lot to prove in terms of execution, and as such remains best suited to more aggressive investors.

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