2023-05-15 13:20:08 ET
Summary
- The stock has lost ground after the Q1 report, but that does not mean there was not a lot to like in the latest report.
- The stock has struggled greatly in recent months, losing over 40% in three months, but there is a good reason why this is not necessarily a bad thing.
- SKYT has a lot of work left to do, including the income statement and the balance sheet, but there is reason to believe the future is bright.
- If someone has the time and resources for a long-term play to reach fruition, then long SKYT is likely worth considering.
SkyWater Technology ( SKYT ) probably deserved a better response than it received after the release of the Q1 FY2023 report. After all, the report contained a number of developments that argue in favor of the bull case for SKYT. For instance, SKYT far surpassed estimates for the top and the bottom line, the latter in particular. SKYT seems to be ahead of schedule in terms of what it has planned for the future, in part due to better-than-expected results. As a consequence, SKYT raised its guidance for FY2023. Still, SKYT did not get much of a lift from all the good news. The stock continued to tread water as it remains in the slump it has been for months. Why will be covered next.
SKYT is making good progress
SKYT is a relatively small foundry in the semiconductor space, certainly in comparison to the heavyweights in the industry. However, the company has big plans that include a target of one billion dollars in revenue before 2030. In order to achieve this goal, SKYT has to spend, including on R&D in order to keep expanding, which is part of the reason why SKYT is running at a loss at the moment.
Still, a stock can be forgiven for being in the red, provided the company shows it is making solid progress in terms of growth and it is reasonable to expect the company will get out of the red within a reasonable timeframe. The good news is that the latest report contained a lot towards strengthening the argument that SKYT is doing just that.
SKYT still posted a non-GAAP loss of $2.47M or $0.06 per share in Q1, but the loss was $0.06 less or half the loss expected. Q1 revenue increased by 37% YoY to $66.1M, which not only beat estimates by $5.3M, but also represents a record high. Adjusted EBITDA was $8.1M, up from minus $4.8M a year ago.
The income statement showed a net loss, which is why it is important to keep track of the balance sheet to assess whether SKYT may or may not be able to handle losses. Overall, while the balance sheet could be better, it's nothing to really worry about. SKYT ended Q1 with total debt of $96.1M, partially offset by $13.8M in cash and cash equivalents. The table below shows the numbers for Q1 FY2023.
(Unit: $1000, except for EPS) | |||||
(GAAP) | Q1 FY2023 | Q4 FY2022 | Q1 FY2022 | QoQ | YoY |
Revenue | 66,094 | 65,087 | 48,121 | 2% | 37% |
Gross margin | 24.9% | 25.4% | (2.0%) | (50bps) | 2690bps |
Operating income (loss) | 1,303 | 1,303 | (27,648) | - | - |
Net income (loss) | (4,273) | (3,041) | (16,606) | - | - |
EPS | (0.10) | (0.07) | (0.42) | - | - |
(Non-GAAP) | |||||
Gross margin | 25.8% | 26.2% | 1.1% | (40bps) | 2470bps |
Adjusted EBITDA | 8,110 | 10,339 | (4,836) | (22%) | - |
Net income (loss) | (2,472) | (1,440) | (12,988) | - | - |
EPS | (0.06) | (0.03) | (0.33) | - | - |
Source: SKYT Form 8-K
The bottom line was much better than expected due to margins that came in much higher than expected. At the start of the year, SKYT was anticipating non-GAAP gross margins in the range of 15-20% for FY2023, but Q1 non-GAAP gross margin turned out to be 25.8%, which is way higher than the 15-20% expected.
The higher-than-expected gross margin was driven by higher-than-expected revenue in Q1, the latter the result of revenue that arrived earlier than anticipated due to accelerated demand on the part of certain aerospace and defense programs. This windfall is expected to continue throughout the rest of FY2023.
As a consequence, SKY appears even more confident of its earlier forecast of at least a 25% YoY increase in revenue in FY2023. In addition, SKYT raised its guidance for FY2023 gross margins in light of the strong start to the year. FY2023 non-GAAP gross margin is now expected to come in somewhere between the high teens and the low twenties, up from 15-20% previously. From the Q1 earnings call:
"Our expectation for the forthcoming quarters is that revenue mix will continue to vary, which will result in varying gross profit contributions quarter-to-quarter. This, combined with a similar to slightly lower revenue expectation for Q2, as a result of the Q1 pull-in, brings us to raise the new gross margin baseline for 2023 to the high-teens-to-low 20% level, up from the 15% to 20% expectation discussed last quarter."
A transcript of the Q1 FY2023 earnings call can be found here .
In addition, gross margin is expected to improve even further in FY2024 to bring it closer to the long-term target of 40%. At the end of FY2024, gross margin is expected to be in the high twenties to low thirties. Higher gross margins should help SKYT get out of the red. In fact, this level of gross margin should be more than enough for SKYT to turn a net profit for the year.
"As for expectations for gross margin performance next year, we anticipate higher revenue levels will lead to increased absorption of our fixed costs from our RadHard and Florida fab investments and more favorable contributions from our Wafer Services business, due to improved pricing and mix.
Therefore, we anticipate gross margin acceleration to continue positioning SkyWater into the high 20s to low 30s gross margin level, as we exit 2024. Further, just as communicated last quarter, we believe 2025 will be the year when all the components of our business model fully come together."
Estimates are projecting a non-GAAP loss of $0.24-0.44 per share on revenue of $260-267M at the end of FY2023, but for FY2024, these numbers are projected to improve to a non-GAAP profit of $0.12-0.40 per share on revenue of $290-332M. In comparison, non-GAAP loss was $1.05 on revenue of $162.8M in FY2021 and non-GAAP loss was $0.74 on revenue of $212.9M in FY2022. There is progress to be noted.
Why the market gave SKYT a lukewarm response
Yet in spite of all the progress reported by SKYT, the market response was tepid at best. The stock actually dropped 7.8% on May 9, the day after the Q1 report, and it was down as much as 19.3% at one point. The chart below shows how the report did not do much to change the trajectory the stock has found itself for the last few months.
However, while the stock remains below where it was before the Q1 report, the stock is still up 30.9% YTD. Note how much the stock rallied earlier in the year. The stock peaked on 2/16 at $15.99, giving SKYT a gain of 124.9% for the year at that point. It was this huge appreciation in the stock why a previous article from February cautioned against going long SKYT, even though there were arguments to be made in favor of SKYT, which includes several advantages over other better known names in the foundry industry.
The article argued that the stock was more likely to head lower after such a huge rally in such a short amount of time, which turned out to be correct since the stock has been treading water since February. The stock got ahead of itself and needed a correction, which is what it got. The fact that a number of high-ranking executives were selling some of their shares further strengthened the case for taking a cautious approach towards SKYT.
Another issue raised was valuations. Keep in mind that SKYT is running at a net loss, something that is expected to remain the case for some time, which is why SKY does not have multiples for a number of commonly used metrics, including P/E ratio. Still, multiples have come down with the stock way off its highs and the ongoing gains in the top and the bottom line.
For instance, SKYT has an enterprise value of $491.6M, which is equal to 18.4 times EBITDA on a forward basis and 43.5 times EBITDA on a trailing basis. While these multiples are higher than most with the median in the sector at 13.3x and 13.9x, respectively, they are much lower than where they used to be. Keep in mind that this is for a company that is expected to grow this year, unlike other foundries that are forecast to contract due to current market conditions, which include relatively soft demand for most types of semiconductor chips.
SKYT | |
Market cap | $414.99M |
Enterprise value | $491.56M |
Revenue ('ttm") | $230.9M |
EBITDA | $11.3M |
Trailing non-GAAP P/E | N/A |
Forward non-GAAP P/E | N/A |
Trailing GAAP P/E | N/A |
Forward GAAP P/E | N/A |
PEG GAAP | N/A |
P/S | 1.69 |
P/B | 7.30 |
EV/sales | 2.13 |
Trailing EV/EBITDA | 43.51 |
Forward EV/EBITDA | 18.45 |
Source: Seeking Alpha
Investor takeaways
Most foundries can be found in East Asia, but SKYT is an exception since it is located in the U.S. As such, it is very likely to benefit from ongoing efforts to bring semiconductor manufacturing back to the U.S. Government initiatives like the U.S. Chips and Science Act should be a powerful tailwind for a company like SKYT.
The fact that SKYT has significant exposure to the defense industry helps in this regard. It should also make SKYT less vulnerable to economic downturns that tend to be a headwind for foundries since defense spending tends to stay resilient even during a recession, unlike discretionary spending and enterprise spending that other foundries depend on.
SKYT is admittedly a small player in the foundry industry and it is not profitable at this time. Both the income statement and the balance sheet need improvement. However, the company is making good progress towards turning a profit, which could come as soon as sometime in FY2024. The rapid gains in gross margin lend confidence to the belief that turning a profit in the not too distant future is achievable.
True, SKY has to invest with capital spending, but that will go down once most of the facilities are finished. By FY2025 SKYT may very well have higher margins than most foundries, especially since it has little to worry about competitors due to the nature of defense spending, which tends to favor U.S. contractors. SKYT, for instance, is accredited as a trusted supplier by the U.S. Department of Defense.
It's true the stock had lost ground for months, which may discourage anyone planning to go long SKYT. On the other hand, this selloff was arguably warranted after the huge rally at the start of 2023. The stock is now close to 42% off its highs. The rate of decline has also slowed down in recent weeks and the stock is off the lows. Some might argue the correction is almost, if not completely over. The charts suggest the stock is more likely to be heading up than down. Now may be a good time to go long SKYT.
I was neutral on SKYT previously, but I am now bullish with the stock having come back to Earth. While SKYT has work to do in terms of the income statement and the balance sheet, there is reason to believe the rapid progress made in recent quarters will continue. There is a captive market out there that SKYT can count on, on top of the secular changes taking place in the semiconductor industry.
Keep in mind though that the foundry market is doing worse than expected. SKYT could therefore encounter some setbacks in the short term from non-defense customers as they struggle with weak demand for semiconductor chips. It's possible SKYT will be affected by this, perhaps as soon as the Q2 report, especially since some of Q2's revenue was pulled into Q1.
Anyone long should therefore take into account the risk of going long a foundry at a time when the outlook for semiconductor demand is uncertain. Bulls may want to dollar average their way into SKYT since short-term setbacks are possible in the current environment. SKYT is a long-term play that will need at least a couple of years to fully play out.
Bottom line, those who can only stick around for a short while will probably want to stay away from SKYT. SKYT has a lot of work left to do and those who lack patience or yearning for instant gratification are likely to be disappointed. SKYT is more suitable for those who have the time and resources for what I think is essentially a start-up to realize its potential. If that is the case, SKYT has a good chance of turning out a winner.
For further details see:
SkyWater Technology: Why Raised Guidance Received A Lukewarm Response