WOLF - Wolfspeed: Kitchen Sinked FY2024 Guidance Is An Opportunity

2023-05-20 00:30:45 ET

Summary

• WOLF has had trouble moving to 200mm wafers at its new facility.
• The company issued very weak FY24 guidance as a result, with low assumptions for the facility to ramp up.
• I'm upgrading the stock to "Buy" on the current set-up.

Back in March, I wrote that the stock of Wolfspeed ( WOLF ) looked too expensive even after a large pullback. Since then, WOLF stock is down another -30%, so let's take a closer look at the name and its most recent earnings report.

Fiscal Q3 Results

For the quarter, the company reported a 22% increase in revenue from $188.0 million a year ago to $228.7 million. Analysts were looking for revenue of $220.1 million. The company credited the revenue beat to solving many of the problems around its production issues on its taller boules, leading to a one-time inventory drain. However, fixing the issues also came at a higher-than-expected cost, as well.

WOLF recorded adjusted EPS of -13 cents, topping the consensus by 2 cents. Adjusted earnings were a loss of -12 cents the prior-year period.

Gross margins came in at 29.8%, a -420 basis point decline. Adjusted gross margins, which exclude stock comp, were 32.3%, down -400 basis points. Gross margins were negatively impacted by lower yield and higher costs on its taller 150mm boules, as well as due to a higher mix of high-volume automotive customers being run on its smaller 150-millimeter diameter wafers at its Durham fab.

Discussing some of the issues ramping up its Mohawk Valley facility on its FQ3 call , CEO Gregg Lowe said:

"First off, we're running wafers right now, 200-millimeter wafers, in the Mohawk Valley. As I mentioned in the prepared remarks, we shipped our first product to an industrial customer, and we're going to ship a couple of million dollars' worth of product this quarter. Our cycle times, our yield, our throughput, initial reliability, all of that out of Mohawk Valley is looking really good. The quality of our crystals and the quality of our substrates as well as the yield in producing those substrates in our materials factory in Durham is also at/or above where we have targeted at this point.

"What we're really talking about here is a challenge of scaling, and scaling the materials operation to feed Mohawk Valley. And basically there are 2 things that are basically slowing that down, so to speak. One is some infrastructure delays that we had things like switchgear and things like that as we expanded in our Building 10 facility in Durham, so basically, supply chain issues with electrical infrastructure here. That's been resolved, and we're now expanding inside a Building 10. And the second is a more methodical approach to growing the capacity, I think that's a prudent point for us to take at this point. So basically, quality of bulls, quality of crystals, crystal height, number of wafers per bull, all of that kind of stuff in line, material flowing through the factory, doing really well, just simply a delay from an infrastructure perspective and a more methodical ramp."

WOLF had -$11.0 million in operating cash flow in the quarter. Free cash flow was an outflow of -$244.9 million. It ended the quarter with $2.2 billion in cash and short-term investments. It had $3.0 billion in convertible notes.

The company had $1.7 billion of design-in wins in the quarter. It said it had a quarterly record for non-automotive design wins-in, including for an EV off-board charger and a heat pump application. The company has $6.7 billion of design-ins this fiscal year and $18 billion since fiscal 2020.

As for the quarter itself, it was a mixed quarter for WOLF. The company beat on revenue, but this was largely a one-time boost that won't repeat. Margins, meanwhile, remain an issue due to higher costs and the company being unable to move some expected production to its 200mm Mohawk Valley facility given ramp-up issues. Scaling Mohawk Valley will be a key for the company over the coming year.

Outlook

For fiscal Q4, WOLF guided for revenue of between $212-$232 million. The guidance assumes low single-digit revenue from Mohawk Valley. Revenue at its Durham facility, meanwhile, is capped, and the company won't see a repeat benefit from the one-time inventory drain it saw in Q1.

WOLF sees Q4 adjusted gross margins to fall between 29-31%. The company said it will continue to work through the cost recovery on the taller 150-millimeter boules. In addition, expected production slated for Mohawk Valley will still take place at its Durham fab.

It forecast a loss of between -79 to -87 cents per share. On an adjusted basis, which excludes stock comp and other items, it guided for an adjusted loss of between -17 to -23 cents.

Looking towards fiscal 2024, the company is projecting revenue of between $1-$1.1 billion. The outlook assumes the company can achieve 20% capacity utilization at its Mohawk Valley facility by Q4 fiscal 2024, while its epi material revenue remains close to current levels.

On its FQ3 earnings call, CFO Neill Reynolds said:

"Additionally, as a result of the ramp time line and continued focus on customer time lines, as I mentioned earlier, we plan to run more auto-related products at a smaller 150-millimeter diameter in the Durham fab for the foreseeable future to support our customers, which will flatten the gross margin trajectory for the next several quarters until Mohawk Valley reaches critical mass. As we are in the early stages of these critical EV ramps, it is important to support our customer ramp schedules, but it will likely keep gross margin in your current levels as the Mohawk Valley ramps to higher output levels. That said, as we reached 20% utilization at Mohawk Valley, we would expect the trajectory for gross margin to improve, because the unit economics are significantly more favorable than Durham."

The company has $2 billion in capex planned for fiscal 2024, and it needs to secure $1 billion in non-government financing before calendar year end. Most of the investment will go towards the construction and tool capacity at its 200-millimeter substrate facilities at JP and Tyler City, as well as at its Durham campus in North Carolina. Capex for FY23 will be around $775 million, below guidance of $1 billion due to timing issues.

WOLF was originally talking about $1.6 billion in revenue for FY24, so its initial guidance is a huge miss from that perspective. That said, its projections are pretty modest, with only 20% utilization at its Mohawk facility by year-end 2024. That is hopefully a low bar that is easily surpassed.

Valuation

Let's re-do my work from my prior article based on its current valuation. If WOLF can generate $4 billion in revenue at 45% gross margin in 2027, it would generate $1.8 billion in gross profits. Adding $5 billion in capex spend to its EV (assumes it raised $1.75 billion already), that would put it at 6.2x 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 13.2x 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 6.2x EBITDA, which would be fairly attractive.

Of course, the company put out some FY24 projections that have already been walked back considerably, and these outer-year forecasts include the ramping of facilities that haven't been built yet. WOLF will need to solve its issues moving to 200mm wavers for any of this to come to fruition.

Conclusion

While future demand for silicon carbide appears to be there from the growth of electric vehicle production and other applications, one of the most important things for WOLF going forward is increasing capacity and operational efficiencies. Right now, the company is struggling trying to move to 200mm wavers. Increasing wafer size isn't always a smooth process, as WOLF can attest to; however, the potential cost benefits are huge.

At the end of the day, whether WOLF's stock works over the next few years will largely depend on margins. To achieve this, WOLF will have to increase wafer sizes, so it's understandable that the stock has sold off amidst its problems trying to move to 200mm wafers.

That said, it looks like the company kitchen-sinked guidance for its FY24. That's always a set-up I like after a stock is down a lot. Low expectations that are easily beatable can be a big catalyst for stock rallies. If WOLF can solve its issues moving to 200mm, the company should easily surpass FY24 estimates.

Given the potential of the market and the big sell-off in the name, I think more aggressive investors can begin to take a starter position in the name. As such, I will raise my rating to "Buy."

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