2023-12-06 06:38:57 ET
Summary
- ALGM has seen its market cap collapse for a couple of reasons, all of which suggest the bull thesis for ALGM may need to be revised.
- Management was able to soothe concerns about demand, particularly in China, but there is reason to believe ALGM is still not in the clear.
- There are more and more reports suggesting the future of EVs is not as bright as previously assumed, which is a problem for a stock like ALGM.
- If ALGM is to return to the heady days from earlier in the year, the issue of where demand for EVs is heading needs to be resolved.
Allegro MicroSystems (ALGM) has seen the value of its stock cut by almost half since August 1 after raising the possibility growth may slow down in the coming quarters. This was after a major rally that saw the stock multiply in value in about a year. However, the most recent report was able to stem the decline in the stock after it offered some soothing words to help ease concerns. Still, while the stock seems to have regained its footing in recent weeks, it may be too early to say the stock is now in the clear. Why will be covered next?
ALGM regains its footing after falling for months
A past article from one year ago rated ALGM a hold after concluding that while ALGM had good prospects, especially with ALGM's high exposure to the growing market for electrical vehicles or EVs, ALGM also came at fairly hefty valuations. A year has passed and the stock is worth $27.33 as of December 4, 2023, less than the $29.86 it was worth on December 27, 2022, when the article was written. The stock has lost 9% YTD.
However, that's not the whole story. It's worth noting that while the stock has fallen in the past year as shown in the chart above, the stock was up big for much of the time. The stock, for example, hit a 52-week high of $53.05 on July 19, which translates to a gain of 76.7% for the year for ALGM. The July 2023 high of $53.05 was also way above the July 2022 low of $19.20, which gives you an idea of how much the stock got bid up in the preceding 12 months.
Why the outlook has become hazy for ALGM
However, ALGM's fortunes changed on August 1 when the stock started to reverse course. The stock descended and the decline continued until the stock got as low as $24.66 on November 1 before the decline came to an end. This is less than half the July 2023 high of $53.03, a major reversal for a stock that had been flying high.
The above moves did not happen for any particular reason on the aforementioned days. August 1 was when ALGM released its Q1 FY2024 report. Up to that point, ALGM was assumed to be a winner from the move towards electrical vehicles, causing investors to flock towards the stock, but the Q2 report put doubt into that assumption.
The market got an unpleasant surprise from what was supposed to be a growth story when ALGM raised the possibility growth could falter. For instance, ALGM pointed to China as a reason for turning cautious, a major issue with China accounting for about a quarter of sales. From the Q1 FY2024 earnings call:
"We are, however, cautious in the near term given the macroeconomic uncertainty with increasing interest rates, inflation and geopolitical concerns. More specifically, we are monitoring China closely, where auto production declined 15% in the first half of calendar '23.
Our sales in China in Q1 declined 13% sequentially or 7% on a comparable 13-week basis. We are seeing multiple factors at play in China."
A transcript of the Q1 FY2024 earnings call can be found here .
The market responded negatively to these comments from ALGM. The stock fell 12.3% on August 1 even though ALGM beat estimates for the top and the bottom line in the Q1 FY2024 report and quarterly guidance was higher than expected. It also marked the start of a decline in the stock that lasted several months.
The decline ended on November 1 as mentioned earlier, which happens to be the day before ALGM released its most recent earnings report. The Q2 FY2024 report was able to stem the decline in the stock even though the report was actually a mixed bag. ALGM did beat estimates for the top and the bottom line in the Q2 FY2024 report as shown in the table below, although it fell short elsewhere.
Note how the non-GAAP gross margin of 58.3% is above the 56% ALGM expects for gross margin in the near term. It is actually above the long-term target of 58% ALGM laid out in its most recent financial model, as detailed in the 2023 Analyst Day. The better-than-expected gross margin was due to a favorable product mix and foreign exchange rates, which pushed non-GAAP EPS to $0.40, a new record high. Automotive accounted for 75% of sales.
(Unit: $1000, except for EPS) | |||||
(GAAP) | Q2 FY2024 | Q1 FY2024 | Q2 FY2023 | QoQ | YoY |
Net sales | 275,509 | 278,293 | 237,666 | (1.00%) | 15.92% |
Gross margin | 57.9% | 56.8% | 55.5% | 110bps | 240bps |
Operating margin | 26.5% | 25.4% | 25.2% | 110bps | 130bps |
Operating income | 72,915 | 70,746 | 59,838 | 3.07% | 21.85% |
Net income | 65,671 | 60,889 | 50,648 | 7.85% | 29.66% |
EPS | 0.34 | 0.31 | 0.26 | 9.68% | 30.77% |
(Non-GAAP) | |||||
Net sales | 275,509 | 278,293 | 237,666 | (1.00%) | 15.92% |
Gross margin | 58.3% | 57.8% | 56.2% | 50bps | 210bps |
Operating margin | 31.3% | 30.8% | 27.9% | 50bps | 340bps |
Operating income | 86,328 | 85,627 | 66,297 | 0.82% | 30.21% |
Net income | 77,731 | 76,533 | 59,758 | 1.57% | 30.08% |
EPS | 0.40 | 0.39 | 0.31 | 2.56% | 29.03% |
Source: ALGM Form 8-K
On the other hand, guidance was soft. Guidance calls for Q3 FY2024 revenue of $250-260M, an increase of 2.5% YoY and a decline of 7.4% QoQ at the midpoint. Keep in mind that Q3 revenue includes contributions from the recent acquisition of Crocus. If not for Crocus, the QoQ decline would be even worse.
The forecast sees non-GAAP gross margin dropping to 54%. This is expected to result in non-GAAP EPS of $0.27-0.31, a decline of 17.1% YoY at the midpoint. ALGM paid $420M in cash to acquire Crocus, which will show up in the Q3 FY2024 report. As of Q2 FY2024, ALGM had cash and cash equivalents of $370M on the balance sheet.
Q3 FY2024 (guidance) | Q3 FY2023 | YoY (at the midpoint) | |
Revenue | $250-260M | $248.8M | 2.49% |
Non-GAAP gross margin | 54.0% | 58.0% | (400bps) |
Non-GAAP EPS | $0.27-0.31 | $0.35 | (17.14%) |
Source: ALGM Form 8-K
However, it was the earnings call that took the spotlight. The market was pleased to hear that demand in China is holding up after the scare it got at the second-to-last earnings call. From the Q2 FY2024 earnings call:
"Last quarter, we had expressed some concerns about trends in China. And I think we were pleased to see that the bookings returned quite strongly for our China business. And certainly, our visit to the region, spending a week on the ground with customers and partners reinforce that the e-mobility trend continues to be really strong and vital within the China customer base. And I think we're just seeing a resumption and a continued acceleration of the order rate."
A transcript of the Q2 FY2024 earnings call can be found here .
Why ALGM may still not be in the clear
The most recent report was able to put an end to the recent decline in the stock. Still, AGLM is way off the highs and it has ways to go to get back to the heady days from earlier in the year when the stock soared higher. In addition, while ALGM may have succeeded in putting at ease some of the concerns some might have about demand in places like China, there is reason to believe the issue of demand has not gone away completely.
It does not help that there are increasing reports demand for electrical vehicles is not as robust as many have long assumed. For instance, there are reports stocks of electrical vehicles are piling up at U.S. dealers due to weaker-than-expected sales. Some high-profile automakers like Tesla ( TSLA ) have resorted to price cuts, which only serves to strengthen the perception demand for electrical vehicles is not what it is supposed to be. A number of top executives from various automakers have also publicly stated their thoughts as to why they believe large sections of the American public is not that enthusiastic about electrical vehicles. None of this is helpful to ALGM.
Keep in mind the bull thesis for ALGM rests in large part, if not entirely, on the belief the market for electrical vehicles will boom for years to come. So all these reports suggesting demand for electrical vehicles is not as strong as assumed are a definite headwind for ALGM. ALGM is perceived as a growth stock, but if growth is not there, then the whole thesis for ALGM falls apart.
ALGM may be below fair value with a caveat
Fair value is subjective. Furthermore, ALGM went public in October 2020, which means there are only three years of reports with which to evaluate ALGM. ALGM has done fantastic during these years, but the numbers may be somewhat misleading since they cover a relatively short time span. For instance, net profit grew at a CAGR of 71-72% in the last three years, but it remains to be seen how representative those numbers are in the coming years.
At the 2023 Analyst Day ALGM did give out ideas as to how it sees the numbers developing according to its financial model. For instance, sales are seen to grow at a CAGR in the low teens with non-GAAP gross margin above 58%. The model sees free cash flow growing at a CAGR of above 25%. These numbers could be used to come up with an estimate for fair value using the discounted cash flow method.
A review of analysts covering ALGM shows estimates put FY2024 revenue in the $1.05-1.07B range. If we then assume ALGM hits its targets according to the model and revenue grows by an estimated 13% on average per year in the next ten years and free cash flow by 25.3% on average, then the fair value is around $44 with a discount rate of 12%. This is well above the current stock price.
Keep in mind that Analyst Day was held in March 2023. Much has happened since and the financial model may need some adjustments, especially in light of recent developments in the market for EVs. ALGM has done well in the three years since the IPO, but if all the recent reports about the state of demand for electrical vehicles are accurate, the coming years may be very different for ALGM.
Investor takeaways
The bull thesis has taken a major dent in recent months. As recently as late July, ALGM was flying high with the market betting on growth in the market for new energy vehicles and electrical vehicles in particular. For instance, ALGM saw its market cap come close to tripling in value in one year. The 2023 Analyst Day predicted strong growth for ALGM as a supplier of components such as ADAS for electrical vehicles.
However, different factors have conspired to take down the stock, which is now worth roughly half of the July peak. ALGM raised the possibility of weakening growth when it suggested demand in China was going down, which triggered a decline in the stock that lasted months. The decline stopped in early November when ALGM reported in its most recent report demand in China had improved, which helped soothe concerns about the state of demand.
The decline has helped lower multiples for ALGM. Multiples were nearing lofty territory last July, but the collapse in the stock has brought them mostly in line with the median. For instance, ALGM has a P/E ratio of about 18 with TTM non-GAAP EPS of $1.51 and a stock price of $27.33.
Still, while the stock has stopped falling, it has not been able to resume the heady days from earlier in the year when the stock soared higher. It has long been assumed the future of electrical vehicles is assured, but recent reports are increasingly questioning whether that assumption is fully grounded in reality. A growing number of reports from different corners suggests demand for electrical vehicles is not as robust as long assumed for different reasons, which threaten the very thesis long ALGM was built upon. This thesis assumed the market for electrical vehicles would grow for many years to come as they completely replace vehicles with internal combustion engines.
If an EV play like ALGM is to resume its earlier rally, then this issue of faltering demand, whether real or perceived, needs to be resolved first. Stocks like ALGM are bought for their growth potential, but if they are not growing like they are expected to because demand for electrical vehicles is not taking off as expected, then the bull case for ALGM falls apart.
I am neutral on ALGM. Long ALGM may be worth a shot if one assumes the recent reports of sluggish demand for electrical vehicles are only temporary and demand will soon recover, especially with the stock price cut in half. On the other hand, it may not be wise to ignore the fact that future EV demand and thus growth may have been overestimated. If what recent reports suggest is correct, then the EV market could be in a slump for some time. ALGM could then also be in a slump for some time to come.
For further details see:
Allegro MicroSystems: A Hazy Outlook Takes A Bite Out Of The Stock