2023-08-09 04:19:14 ET
Summary
- Siltronic AG: I recommend a buy, with growth recovery expected in the coming years after a challenging period.
- Despite declines in sales and earnings, the company has shown relative resilience within a weakening market.
- The semiconductor industry's strong growth drivers support Siltronic's growth.
Overview
My recommendation for Siltronic AG ( OTCPK:SSLLF ) is a buy rating as I expect 3Q23 to be the trough and it will see growth recovery in the coming years. There should be no issue with growth returning to positive territory as long as the underlying industry growth driver remains strong.
Business
SSLLF manufactures hyperpure silicon wafers. The Company offers products including non-polished and epitaxial coated wafers with different diameter sizes. SSLLF caters its products worldwide for use in computers, smartphones, flat-panel displays, navigation systems, automotive engine control systems, and many other applications.
Recent results & updates
2Q23 sales for SSLLF were reported down 14.8% to €403.7 million, 2Q23 EBITDA was down 22.1% to €118 million, 2Q23 EBIT was down 32.1% to €70.3 million, and 2Q23 EPS was down 31.0% to €1.83. Although the numbers look bad when viewed in isolation, I believe they demonstrate relative strength in light of the ongoing market weakness. In particular, sales were stable q/q, in accordance with management's projections. The inventory correction at semi manufacturers is likely to blame for the significant drop in volumes, which I doubt will surprise anyone. High customer inventories, especially in memory, continue to put downward pressure on volumes, but prices have remained stable. Similar to management's forecast of continued weakness in 2H23, I anticipate a volume decline in Q3 as a result of further postponements. Other industry players ( Samsung and SK Hynix ) have indicated that the low point for the semi-con market will be in 2Q23, so I anticipate that 3Q23 will be the bottom for SSLLF. However, I should point out that even if logic inventory levels return to normal in 2024, the memory correction may still take longer than expected due to order adjustments made late by some customers.
Management provided updated forecasts for FY23. Now that 2H23 is more clear, management anticipates sales of €1.462–€1.553 billion and EBITDA of €380–€465 million (or 26–30% margin). Considering the industry's strong foundation, I remain optimistic about SSLLF's future expansion. To begin, I do not believe there will be a fundamental shift away from the current trend of digitization. The downstream fab production capacity in 200mm and 300mm are expected to grow at a CAGR of 20% and 10%+ , respectively, in the coming years due to the increasing digitization. In addition, higher silicon content is being driven by the widespread adoption of 5G networks, IoT, high-performance computing, artificial intelligence, electric vehicles, and the ongoing expansion of advanced driver assistance systems, all of which contribute to strong industry growth.
These underlying growth drivers align with SSLLF's journey towards improving margins, as I anticipate that the challenges related to costs have reached their peak in 1H23. Margin expansion in FY24 should not be surprising given lower electricity costs and input prices. Moreover, the ramp up of the new high-margin Singapore fabrication facility should bolster profitability starting in FY24, with the EBITDA margin projected to surpass 50% in the medium term, as indicated in the 2Q23 earnings call.
Altogether, I think the business has gone through a rough patch over the past few quarters due to industry dynamics. I expect things to get better from here, as 3Q23 should be the trough for the business.
Valuation and risk
Author's valuation model
According to my model, SSLLF is valued €148 in FY24, representing an 84% increase. This target price is based on my expectations that growth will recover in FY24 and FY25, given that FY23 is likely to be the trough. Growth is well supported by the underlying tailwinds, so I don’t see an issue with growth recovering.
SSLLF is now trading at 16x forward PE, which I think makes sense as the market is likely to be anticipating strong recovery growth in FY24 as well. I assumed the same multiple as what the market is expecting today for my model. When compared to other semiconductor manufacturing businesses, SSLLF trades at a discount. This discount is warranted given that there is still a risk that 3Q23 might not be the trough given the situation with Memory correction. As SSLFF shows a faster path to recovery, there is potential for valuation to move towards peers’ levels.
The risk with SSLLF is its balance sheet. According to the latest data, it is in a net debt position of around $170 million. Consensus is expecting SSLLF to spend CAPEX of another $540 million and $300 million in FY24 and FY25. If the industry slump continues much longer than everyone expects, I am concerned that SSLLF might need to tap the capital markets to meet CAPEX.
Summary
SSLLF is poised for growth recovery after a challenging period, and I anticipate 3Q23 to mark the trough. Despite recent declines in sales and earnings, results demonstrate relative resilience within a weakening market. The semiconductor industry's strong underpinnings align with SSLLF's potential, particularly in the realm of digitization, 5G networks, IoT, AI, electric vehicles, and more. Margin should expand in FY24 due to lower costs and the ramp up of the high-margin Singapore facility. Although trading at a discount to peers, SSLLF's recovery trajectory suggests potential for valuation to align more closely. However, the balance sheet's net debt position presents a risk, requiring caution amid industry challenges.
For further details see:
Siltronic AG: Growth Should Recover After The Trough In Q3 2023