2023-07-15 05:55:12 ET
Summary
- POWI has been hit by a downturn, but an apparent resolution to the problem has set off a rally in the stock.
- POWI is betting it all on GaN due to its superior performance, especially for EVs due its growth prospects.
- China has imposed export controls on gallium, which could affect the adoption of GaN in EVs and anything else that uses gallium.
- It is not clear how China will enforce export controls, but if gallium becomes harder to find, POWI’s foray into EVs will be set back.
Power Integrations ( POWI ) is currently on a roll. The stock has rallied ever since POWI hinted at the end of the downturn that has led to a big drop in earnings. The market applauded the updated outlook from POWI at the most recent earnings call, which called for earnings to improve. It also liked the prospect of POWI’s foray into the gallium nitride or GaN market for electrical vehicles or EVs, which could potentially become the main driver of growth due to the size of the automotive market. However, while GaN may have strong prospects and POWI has benefited as a result, the government of China may have thrown a spanner into the works. Why will be covered next.
POWI has left its problems behind or has it?
The chart below shows how POWI has gone up and down in 2023. POWI got off to a strong start in 2023 along with the semiconductor sector as a whole, but weak guidance on February 6 marked the start of a decline that lasted months. A previous article goes into deeper detail as to why guidance came in way below expectations.
Source: Thinkorswim app
However, this all changed on May 5, the day after POWI released its most recent guidance. POWI was barely up for the year at that time, but a strong rally followed, which pushed the stock from $73.64 on May 4 to $98.89 on July 13, a gain of 34.3%. This rally boosted YTD gains to 37.9%.
Why the market changed its view on POWI
The rally in the stock was triggered by several updates from POWI, all of which beefed up sentiment towards POWI. As mentioned before, POWI disappointed with its Q1 guidance earlier in the year. However, Q2 guidance of $117-127M surpassed expectations. This is still down 33.7% YoY at the midpoint as shown below, but it also represents a sequential increase of 14.8% compared to Q1.
Q2 FY2023 (guidance) | Q2 FY2022 | YoY (midpoint) | |
Revenue | $117-127M | $184.0M | (33.70%) |
GAAP gross margin | 51.5% | 58.1% | (660bps) |
Non-GAAP gross margin | 52.0% | 58.5% | (650bps) |
Source: POWI Form 8-K
Q1 is seen to be the bottom. Keep in mind that POWI has been negatively affected by the recent downturn in the semiconductor industry, which has led to a drop in demand and earnings by extension. The table below shows how the quarterly numbers have declined, culminating in Q1’s 41.6% YoY decline in revenue to $106.3M and a 73.1% YoY decline in non-GAAP EPS to $0.25. On the other hand, if POWI has it right, then the aforementioned numbers are as bad as it gets.
(Unit: $1000, except EPS) | |||||
(GAAP) | Q1 FY2023 | Q4 FY2022 | Q1 FY2022 | QoQ | YoY |
Revenue | 106,297 | 124,770 | 182,149 | (14.81%) | (41.64%) |
Gross margin | 50.8% | 54.0% | 55.3% | (320bps) | (450bps) |
Operating margin | 5.4% | 16.7% | 28.0% | (1130bps) | (2260bps) |
Income from operations | 5,757 | 20,892 | 51,047 | (72.44%) | (88.72%) |
Net income | 6,875 | 22,815 | 46,248 | (69.87%) | (85.13%) |
EPS | 0.12 | 0.40 | 0.77 | (70.00%) | (84.42%) |
(Non-GAAP) | |||||
Revenue | 124,770 | 124,770 | 172,654 | (14.81%) | (41.64%) |
Gross margin | 51.5% | 54.7% | 55.7% | (320bps) | (420bps) |
Operating margin | 12.8% | 22.5% | 33.3% | (970bps) | (1050bps) |
Income from operations | 13,607 | 28,028 | 60,723 | (51.45%) | (77.59%) |
Net income | 14,224 | 27,866 | 55,802 | (48.96%) | (74.51%) |
EPS | 0.25 | 0.48 | 0.93 | (47.92%) | (73.12%) |
POWI also updated its FY2023 outlook, which not only called for the end to the recent downturn, but also called for a second half of the year that is significantly better than the first half. From the Q1 earnings call:
“While the cyclical correction has been painful, we are pleased that things are playing out as we expected. As usual, we were among the first in our industry to see the downturn, and we are now among the first to emerge with a recovery beginning in Q2. As we anticipated, smartphones are leading the way out after having been the first end market to correct and with other end markets to follow. While the pace of the recovery is still to be seen, we expect the second half of the year to be significantly better than the first half, not only in terms of revenues but also margins and internal inventories, which are trending in the right direction, starting with the June quarter.”
A transcript of the Q1 FY2023 earnings call can be found here .
The market has revised its earnings expectations in line with the latest outlook. Consensus estimates predict POWI will end up with non-GAAP EPS of $2.00 on revenue of $545.6M in FY2023. POWI is expected to earn $0.59 on revenue of $229M in H1, which implies a much better H2 than H1. In comparison, POWI earned $3.29 on revenue of $651.1M in FY2022.
That’s not all. The market also liked what POWI is doing to keep growing in the future. POWI discussed some of the initiatives it believes will drive growth forward, the EV market in particular.
“Overall, we continue to be excited about our progress in the EV market, which we estimate will be a $1 billion SAM for us by 2027. We are on track for our mid-single-digit millions this year in terms of revenues and more importantly, design in activity is accelerating with a 50% increase in opportunities.”
The EV market is expanding rapidly, which could provide the fuel for growth at POWI. POWI is therefore trying hard to get a slice of EV market by developing products suitable for EVs. The recent appointment of Ravi Vig, the former CEO of Allegro MicroSystems ( ALGM ), and his experience with the automotive market should be seen in that light.
For now, POWI is somewhat reliant on the mobile market with fast chargers. However, smartphone demand has cooled off from where it used to be. The EV market, on the other hand, is still very much in growth mode, so making inroads into the EV market with, for instance, EV chargers, could make all the difference.
Keep in mind that if POWI’s succeeds in breaking into the EV market, POWI could become an EV play. EV plays have long been the darlings of the investor community and if POWI becomes one as well, the stock is likely to benefit greatly.
How China could spoil the party for POWI
POWI specializes in high-voltage power conversions. In more recent years, POWI has focused on semiconductor designs utilizing GaN, which is better suited for these high-voltage applications than traditional silicon designs since the former have several advantages, including higher efficiency, than the latter.
However, most of the global supply of raw gallium comes from China, which has recently decided to impose export controls on gallium. According to the USGS , 550,000 kilograms of gallium was produced in 2022 and 540,000 or 98.2% came from China. Keep in mind that the Chinese government has not prohibited the export of gallium. Export requires government permission, which China has said it will grant, provided relevant regulations are met.
Nevertheless, the export controls have created uncertainty and concerns the continued supply of gallium is not guaranteed. In theory, the supply of gallium could be reduced significantly given that almost all of it comes from China and, while doable, finding a replacement could be time-consuming and costly. It’s possible, if not likely, that EV makers will take this into account when deciding whether they should select something that requires GaN, which includes POWI’s designs.
The last thing automakers want to do is to halt or reduce car production because an important component is not available. This risk may cause some to decide not to use anything based on GaN, which would negatively affect POWI, especially with POWI having staked pretty much its entire future on the use of GaN.
Trade restrictions may not come at a good time for POWI
Note that POWI already relies heavily on the availability of GaN. POWI’s fast chargers for smartphones, for instance, cannot do without GaN. It all depends on how the export controls are enforced, but if there are large disruptions to the supply chain, POWI could be affected by China’s decision to impose export controls.
It’s also worth mentioning that anything that could potentially throw off the recovery for POWI comes at a bad time with valuations where they are. Multiples have expanded with the expectation of POWI going through a recovery, but if the recovery gets derailed by China’s export controls, then multiples may already be too high.
For instance, POWI trades at 48.5 times non-GAAP earnings with a trailing P/E of 37.3. In comparison, the median in the sector stands at 23.8x and 19.3x respectively. It’s therefore important that the expected recovery in earnings does not get derailed because if it does, the stock may have to be repriced to account for less-than-anticipated growth.
POWI | Sector median | |
Market cap | $5.65B | - |
Enterprise value | $5.20B | - |
Revenue (“ttm”) | $575.3M | - |
EBITDA | $174.0M | - |
Trailing non-GAAP P/E | 37.30 | 19.26 |
Forward non-GAAP P/E | 48.52 | 23.78 |
Trailing GAAP P/E | 42.53 | 26.00 |
Forward GAAP P/E | 67.11 | 26.23 |
PEG GAAP | - | 0.74 |
P/S | 9.65 | 2.92 |
P/B | 7.28 | 3.21 |
EV/sales | 9.04 | 3.09 |
Trailing EV/EBITDA | 29.89 | 15.19 |
Forward EV/EBITDA | 37.54 | 14.73 |
Source: SeekingAlpha
Investor takeaways
POWI has staged a strong turnaround after the struggles from earlier in the year. The downturn in demand has caused earnings to shrink, but the most recent outlook suggests the worst has passed. Earnings are not expected to get any worse than Q1. POWI is on the path to recovery from the recent downturn. The stock has rallied in recent weeks thanks to the prospect of improved earnings.
However, while POWI has been rolling along, the government of China may have put up a roadblock down the road. China has imposed export controls on gallium, which is used to make a compound semiconductor like GaN. It just so happens that POWI has decided to stake its future on GaN due to its superior performance.
POWI’s plan to enter the EV market, for instance, is based on the higher efficiency possible with GaN. POWI has high hopes for the EV market since it is a market that has good growth prospects, unlike say the smartphone market. If POWI is to see growth in fast chargers for smartphones, it will be because of higher silicon content and not so much unit sales due to the slump in demand for smartphones. EVs are different since the market is still growing.
These plans may be derailed, depending on how China goes about implementing its export controls. In the best case, China does not limit the amount of gallium available. In this case, POWI should not be affected. In the worst case, China does reduce the flow of gallium needed to produce a range of products. In this case, POWI could be impacted, depending on how scarce or costly gallium becomes. This could affect the slope of the recovery for POWI, which is something POWI cannot use since multiples have greatly expanded on the premise of an unimpeded recovery.
I am neutral on POWI. What the ultimate impact of China’s export controls will be cannot be stated for sure at this time. What is safe to say is that export controls add a level of uncertainty and risk to automakers and anyone who is thinking about switching to GaN. They may decide to delay if not cancel the use of GaN altogether, at least until there is more clarity on export controls. This would negatively impact sentiment towards POWI since entry into the EV market has contributed to the recent change in sentiment.
Bottom line, while POWI has addressed its problems from earlier in the year, a new one may have popped up, depending on how the export controls on gallium are implemented. If the flow of gallium is left uninterrupted, POWI is in the clear. But if gallium is cut off, companies needing gallium need to watch out, POWI included.
For further details see:
Power Integrations: Inroads Into The EV Market With GaN May Hit A Roadblock