2023-10-20 12:59:46 ET
Summary
- KEYS demonstrates resilience and adaptability, with a commendable financial performance and focus on R&D, positioning them for future growth.
- Expansion into key sectors like aerospace, defense, and automotive EV/AV, along with sustained demand for silicon photonics solutions, highlights KEYS's readiness to embrace emerging technologies.
- KEYS's strategic pivot towards software-centric solutions and the pending acquisition of ESI Group reflect a forward-thinking approach.
Overview
My recommendation for Keysight Technologies ( KEYS ) is a buy rating. KEYS has recently showcased a commendable financial performance, achieving record figures in both revenue and earnings per share for the third quarter. While there were some challenges, as evidenced by the lower-than-expected order intake, the company's resilience is highlighted by the consistent R&D investments from its customers, signalling a commitment to future innovations. KEYS has also made significant strides in key sectors, notably aerospace, defense, government, and the burgeoning automotive EV and AV domains. Their growth in these areas not only speaks to their credibility but also hints at potential revenue stability. Additionally, amidst the challenges in the semiconductor sector, KEYS stands out with its high demand for silicon photonics test solutions, emphasizing their adaptability in this dynamic industry. Their strategic shift towards software-centric solutions, further amplified by their intent to acquire ESI Group, underscores their vision and adaptability. In essence, KEYS is well-positioned to harness current industry trends and is primed for future growth.
Business
KEYS is a leading global company specializing in electronic measurement solutions, catering to industries ranging from communications and aerospace to semiconductors and education. KEYS provides advanced hardware and software solutions that assist engineers, researchers, and professionals across various sectors in designing, testing, and optimizing their products and systems. Their offerings encompass a broad range of applications, including wireless communications, aerospace and defense systems, and digital solutions.
Over the past 5 years, KEYS has demonstrated robust top-line revenue growth. However, in 2020, the COVID-19 pandemic led to a decline in KEYS revenue of approximately 2%. As the impact of COVID-19 subsided in 2021 and 2022 and as economies reopened, KEYS revenue also rebounded. The company's compound annual growth rate over these five years stood at 7%. Impressively, in 2022, KEYS reported a double-digit growth of 10%, still continuing to surpass its 5-year CAGR.
When it comes to net income, KEYS's performance has been notably impressive, showcasing consistent growth. In 2018, the company reported a non-GAAP margin of 16%. By 2022, this figure had risen to 26%, marking a significant expansion of 8% over the period.
Recent Results & Updates
The company reported revenue of $ 1.38 billion , up 1% on a core basis, marking a record for the third quarter. The gross margin stood at 66%, and the operating margin was a record 31%. The earnings per share amounted to $2.19, an all-time high.
While the company's orders for the quarter landed on the lower end of their expectations, suggesting potential challenges in demand or in converting leads into confirmed orders, there was a silver lining. Despite this dip in order intake, there was a consistent and positive trend in customer research and development (R&D) spending. This steady R&D investment is a promising sign, indicating that customers remain committed to innovation, which could translate to future demand for KEYS offerings.
Furthermore, the company witnessed growth in the aerospace, defense, and government sectors. These sectors are known for their long-term contracts, high regulatory requirements, and significant barriers to entry. KEYS's growth in these areas is a testament to their credibility, product quality, and ability to meet the stringent demands of these sectors. Such growth can also be seen as a sign of potential revenue stability, given the often multi-year nature of contracts in these domains.
But perhaps one of the most exciting revelations was KEYS's growth in automotive electric vehicles ((EV)) and autonomous vehicles ((AV)) solutions. The automotive industry is in the midst of a transformative phase with the rise of EVs and AVs. KEYS's active participation in this transformation, underscored by their strategic win with a prominent European Original Equipment Manufacturer ((OEM)) for an EV battery test system, positions them favorably in this rapidly evolving landscape. Their involvement in the EV and AV sectors is not just timely but strategic, tapping into what is widely regarded as the future of transportation.
In essence, while there might be short-term concerns due to the lower order intake, the consistent R&D spending by customers and growth in pivotal sectors like aerospace, defense, government, and automotive EV/AV paint a promising picture for KEYS future prospects. The company appears to be in sync with current industry trends and is poised to benefit from future technological shifts.
In the midst of challenges faced by the semiconductor sector, a bright spot for KEYS Technologies has been the sustained high demand for their silicon photonics test solutions. Silicon photonics, which integrates optics with traditional semiconductor processes, is emerging as a pivotal technology in the industry. It harnesses the power of photonic systems to transmit data among computer chips, offering a promising avenue to meet the escalating data rates in modern computing. The robust demand for KEYS solutions in this domain suggests that the industry is increasingly gravitating towards the benefits of silicon photonics, such as enhanced speed, power efficiency, and cost-effectiveness. KEYS's prominence in providing these testing solutions underscores their adaptability and forward-thinking approach, positioning them well to cater to the next wave of semiconductor innovations. As the landscape of the semiconductor industry evolves, KEYS's ability to tap into and serve emerging technologies like silicon photonics indicates their potential for continued relevance and growth.
In the evolving landscape of the technology industry, KEYS has adeptly navigated the shift toward software-centric solutions. A significant indicator of this transition is that software and services now make up a substantial one-third of the company's total revenue. This not only underscores the growing customer reliance on KEYS software offerings but also highlights the company's strategic diversification of its revenue streams. Such a move is pivotal in mitigating the risks associated with market fluctuations in specific sectors.
Further solidifying their commitment to software solutions is KEYS's intent to acquire ESI Group , a frontrunner in the realm of virtual prototyping. Virtual prototyping, which allows for the simulation, testing, and optimization of products in a digital environment before physical production, is becoming increasingly crucial in today's fast-paced tech world. By integrating the expertise of ESI Group, KEYS is poised to offer an even more comprehensive suite of solutions, addressing a wider array of challenges in product development and testing. This acquisition not only broadens KEYS reach into new markets and customer segments but also underscores their vision to stay at the forefront of industry trends.
All in all, KEYS's pronounced focus on software and its strategic moves, like the ESI Group acquisition, showcase the company's adaptability and forward-thinking approach. As the preference for software-driven solutions continues to grow in the tech sector, KEYS's alignment with this trend signals a promising path for their sustained growth and market relevance.
Valuation and Risk
According to my model, KEYS is valued at $138.12 in FY24, marking a 10% increase. This valuation stems from my growth predictions of 1% for FY23, aligning with the guidance from KEYS's management in their earnings report, and 6% for FY24, which slightly exceeds the market consensus. Several pivotal factors bolster my growth expectations for KEYS. Firstly, their expanding presence in the aerospace, defense, and government sectors promises consistent revenue, given the long-term contracts these sectors typically offer. Secondly, the unwavering demand for KEYS's silicon photonics test solutions showcases their readiness to harness the next wave of semiconductor advancements. Lastly, KEYS's strategic pivot towards software-centric solutions, evident as software and services now constitute one-third of their total revenue, underscores their adaptability and forward-thinking approach. Given these dynamics, I remain optimistic about KEYS's growth prospects in the upcoming years.
Currently, KEYS is trading at a forward EV/EBITDA multiple of 13.22x. With a net margin of 21.79% and an EBITDA margin of 29.67%, KEYS lags behind its peers in profitability metrics. This is reflected in its valuation, as KEYS trades at a slightly lower forward EV/EBITDA compared to TER (EV/forward EBITDA of 15.9x, net margin of 22.9%, EBITDA margin of 30.6%). Given this context, I consider KEYS's valuation to be reasonable. Based on its prevailing forward EV/EBITDA, my target price for KEYS is $138.12. When compared with its current trading price of $126.01, this represents a potential upside of 10%. Given these factors, I recommend a buy rating for KEYS.
Given the global nature of the semiconductor and electronics industries, KEYS is exposed to potential supply chain disruptions and geopolitical tensions. Over the past few years, trade disputes, tariffs, and other geopolitical events have impacted global supply chains, leading to increased costs, delays, and uncertainties. If KEYS faces challenges in sourcing critical components or experiences delays in its supply chain, it could impact their ability to deliver products on time, potentially leading to missed revenue opportunities and decreased customer trust. Additionally, any escalation in geopolitical tensions or further trade restrictions could adversely affect KEYS's operations, sales, and profitability, thereby impacting its stock price.
Summary
KEYS has demonstrated strong financial performance, marking notable achievements in both revenue and earnings per share for the third quarter. While the company faced challenges in order intake, the unwavering commitment to R&D by its customers showcases a silver lining, hinting at a continued focus on innovation and potential future demand for KEYS offerings. Strategically, KEYS has solidified its position in pivotal sectors such as aerospace, defense, and government, benefiting from the stability offered by long-term contracts. Their active engagement in the transformative automotive EV and AV sectors, along with the sustained demand for their silicon photonics test solutions, emphasizes their adaptability in a dynamic tech environment. Additionally, KEYS shifts towards software-centric solutions and their intent to integrate expertise from the ESI Group further accentuates their forward-thinking approach. In essence, KEYS's strategic initiatives, alignment with industry trends, and adaptability paint a promising picture for their future growth and market position. Therefore, I recommend a buy rating for KEYS.
For further details see:
Keysight Technologies: A Global Leader Continuously Advancing Its Dominance