2024-01-08 21:53:30 ET
Summary
- Axcelis is a quality company with a moat in its niche market, offering high returns on capital and a growing total addressable market.
- ACLS will benefit from the EV transition and the electrification of vehicles.
- Axcelis has experienced outstanding growth in the past five years, with strong financials and a robust balance sheet, but faces risks such as management changes and the US-China chip war.
- There is potential for multiple expansion coupled with solid organic growth.
- It is trading around a fair price, not a cheap one.
My Thesis
Axcelis ( ACLS ) is a quality company that I believe has a moat in its niche market. It possesses several attributes I consider when researching a company, including high returns on capital, a growing total addressable market, high margins, technological advantage, and a robust balance sheet.
I believe that current prices are fair, and buyers today will do well. While it is not a cheap stock, at a fair price, it could still be a good stock to own.
Business & Industry
Axcelis operates in the ion implant market, holding a significant market share of about 44% . The ion implantation process is complicated but crucial in semiconductor manufacturing. The technological details might be too complex for most of us, so we'll focus on other aspects that can help us understand the business.
In addition to the products Axcelis sells, it profits from aftermarket services and maintenance of the machines, constituting 20% of the business and boasting higher margins.
What interests me about Axcelis is its position as the market leader. In the Q3 earnings call, CEO Russell Low described Axcelis' advantages in the power device market:
Axcelis is the only ion implantation company that can deliver complete recipe coverage for all power device applications. We are considered a technology leader and the supplier of choice, providing the best product family and manufacturing capabilities. This means that using Axcelis tools provides the lowest risk path to high-volume manufacturing required to support aggressive fab implants.
Now, why am I interested in this niche market? It's because its customers are operating in high-growth markets. For example, the silicon carbide market is projected to grow north of 20% in the following years, led by global semiconductor companies like STMicroelectronics, on which I wrote last week . These semiconductor companies will experience increased demand from the electrification of vehicles and the EV revolution. The SiC market is a part of the Power Device market, constituting approximately 39% of Axcelis' revenue (22'). Another example of a growing market is the image sensor market, which captures 10% of Axcelis' business and is projected to grow at high single digits and maybe even double digits. Another market expected to grow, as a result of the AI revolution, is the memory market, with both NAND and DRAM together representing 16% of Axcelis' revenue.
SiC growth ( McKinsey )
In short, the Total Addressable Market of Axcelis is growing, and Axcelis is well-positioned inside to flourish.
Now, we should not underestimate competition, as Axcelis' major competitor is the giant Applied Materials ( AMAT ), which is the only company, except for Axcelis, able to deliver the whole ion implantation package:
we mainly compete against Applied Materials, Inc. Axcelis, and Applied Materials are the only ion implant manufacturers with a full range of implant products, as well as service and support infrastructures able to service our customers globally.
Based on the high margins Axcelis presents, it seems like there is healthy competition where both companies are making profits, rather than engaging in a pricing war.
Numbers & Outlook
The last five years have been outstanding for Axcelis, with the top line growing at a 19% CAGR during this period. This growth is also reflected in the stock price, with an amazing 560% return. The run became even more impressive with the operating leverage Axcelis has, as EBIT margins jumped from 7% in 2019 to the current 22% area.
Top line & margin growth (finchat.io)
This growth in margins has contributed to the most important factor besides revenue growth, which is returns on capital. High and preferably growing returns on capital are a huge factor in long-term value creation for a company. A recent study by Michael Mauboussin shows that a high and growing spread between a company's Weighted Average Cost of Capital and its Return on Invested Capital is a common trait among compounders. I also like to follow Terry Smith's favorite metric, which is Return on Capital Employed (ROCE). In my view, the combination of high ROCE and solid top-line growth is the most important factor. If you manage to buy such a business at a good price, you have a compounder.
November Q3 earnings were also a success. Revenue grew 27% YoY, even when the overall industry is in a downturn. The EBIT line grew at 33%, adding to the margin expansion. The full-year outlook is positive as well:
2023 annual revenue is expected to be greater than $1.1 billion, representing year-over-year revenue growth of around 20% in a year in which overall WFE is expected to decrease by 20% to 30%.
The outlook for 2025 suggests sales to be at 1.3 billion, indicating a slowdown in growth from recent years, representing an 8.3% CAGR. This makes sense, as the semiconductor industry's cyclicality will affect fabs production and, as a result, also the demand for Axcelis' products. Increasing or decreasing capital expenditures of semiconductor foundries directly impact Axcelis. Margins are also projected to grow by 2025, with gross at 45%, EBIT at 26%, and Free Cash Flow at 25%. The slower growth is my guess due to the lower earnings multiple relative to the historical mean.
Aside from the solid growth and margin improvement, Axcelis has a robust balance sheet , with zero debt, plenty of cash at 142 million, plus 318 million in short-term investments, and good liquidity with a quick ratio above 2.
Another positive financial indicator is the buybacks Axcelis initiated, reducing shares outstanding by almost 1% this year, in contrast to the investor dilution it experienced in the recent decade. This is a very positive indicator in my view.
Few Major Risks
Despite having many qualities, I see a few major risks looking forward. The first is the management change. Both the new CEO and CFO assumed their roles in 2023, signifying a significant shift altogether. However, to make it more of a soft landing, the previous CEO, Mary G. Puma, is now the chairperson of the board. Under her leadership, Axcelis achieved amazing returns.
Another risk I see is the China risk. The US-China chip war has been in the news all year, with restrictions on companies such as NVIDIA ( NVDA ) and ASML ( ASML ) to export to China. Thirty to fifty percent of Axcelis' revenue is derived from China. Restrictions on Axcelis, an American company, could create a hole in its revenue. This is a very major risk in my view because it's uncontrollable.
Another risk is limited customer supply, which means the loss of a customer is a significant loss of revenue. Customer relations are critical in this business.
our top ten customers accounted for 59.4% of our net sales, in comparison to 69.5% and 74.0% in 2021 and 2020, respectively. None of our customers have entered into a long-term agreement requiring it to purchase our products. One of our largest customers, SMIC, is based in China, which is subject to U.S. export controls risks.
The most significant risk, in my view, is the China risk, but I wouldn't underestimate the others.
Valuation
This is an interesting one. At a forward P/E of 14, Axcelis seems very attractive in my view. Finding high Return on Capital businesses at such a P/E, with solid growth, is pretty rare. I assume the lower multiple is from both slower projected growth and the US-China risk. However, I believe one of the strongest factors is a return to the mean. Axcelis' P/E mean is more than 20, giving us the potential for multiple expansion. Another important ratio is the PEG. Assuming a 10% earnings growth, we get a 1.4 forward PEG ratio, a reasonable price in my view. From a multiple standpoint, the stock looks attractive. However, the Discounted Cash Flow suggests otherwise.
Using the management guidance for the end of 2023 and the guidance for the 2025 business model, in which the company projects improvement in EBIT margin to 26%, I use an 11.7% WACC and a 2.5% terminal growth. The growth after reaching $1.3 billion in 2025, I assume will be higher, at around 12%, as the semiconductors market returns to more of a growth phase. I assume the margins will expand by 0.5% a year. This growth is still much lower than past numbers.
DCF (finchat.io)
DCF (finchat.io)
The derived result is a stock around fair value and might even be overvalued. So, the DCF picture is less optimistic.
Considering both valuation methods, the truth might be in the middle, and the stock is attractive yet probably not cheap.
Conclusions
Considering the risk/reward here, I think the stock is a buy. I would rate it as a strong buy if not for the China risk and the management change. A 14 forward P/E for a high Return on Capital company in a growing industry is pretty cheap if not for the above risks. The important thing for me to monitor is the chip war with China as well as new management decisions. I will do future articles regarding those risks.
Looking forward to your comments.
For further details see:
Axcelis Technologies: Capitalizing On The EV Revolution - A Classic GARP Opportunity