2023-11-06 04:53:19 ET
Summary
- Ultra Clean Holdings has seen a decline in share price and disappointing earnings, with sales falling and adjusted earnings lower than expected.
- After a boom during the pandemic, margins have come down a long way, to the point at which no realistic earnings are reported here.
- Despite the recent decline in share price, the company is still not profitable, but the acquisition of HIS Innovations Group may provide some potential for improvement.
Early in September, I concluded that the outlook for Ultra Clean Holdings ( UCTT ) was not so clean. This came after the company had seen a painful retreat post the pandemic, and despite acquisitions and diversification attempts, Ultra Clean was breaking even at best, making investors rightfully cautious.
Ever since, Ultra announced somewhat mixed third-quarter results, with margins coming in lower than anticipated, while announcing an interesting bolt-on deal. With shares down 20% since September, the appeal has improved, mostly on the back of the decline in the share price, as margins remain the point of focus here.
Enabling Semiconductor Technology
Ultra Clean Technology is an active enabler of semiconductor technology, acting in the so-called preparation phase which includes front-end processing, lithography, CMP, implant, etch deposition, and wafer cleaning.
Pre-pandemic sales hovered around the billion mark in the years 2018/2019, although operating margins only came in at mid-single digits, in part being the result of the lower value-added activities of the firm, as well as the power of its customers with Lam Research ( LRCX ) and Applied Materials ( AMAT ) being responsible for about two-thirds of sales at the time.
A $20 stock pre-pandemic rose to levels in the sixties in 2021 as the pandemic boosted demand with revenues trending at a run rate to $1.5 billion in 2020, as operating earnings power around $100 million bolstered earnings power towards $2.50 per share.
That optimism boosted Ultra's confidence, and the company announced a $348 million deal for Ham-Let, a manufacturer and distributor of purity and industrial flow systems. This deal and organic growth meant that 2021 sales rose to $2.1 billion and nearly $2.4 billion in 2022.
Adjusted earnings per share rose to $4.20 per share in 2021, falling to $3.98 per share in 2022, but this was after no less than 12 earnings adjustments were made, with realistic earnings trending somewhere in the $3s.
2023 - Though So Far
After a boom since the start of the pandemic, Ultra Clean has seen a tough 2023 so far. First quarter sales fell 23% to $433 million, as adjusted earnings of $0.17 per share were very modest. Second quarter sales were stuck at $422 million, with adjusted earnings again coming in at $0.17 per share.
With third quarter sales seen stagnant at $430 million, and earnings seen at $0.18 per share, the disappointing factor is that despite a $1.7 billion run rate, realistic earnings were largely evaporated. After all, a $0.75 per share adjusted earnings per share run rate comes ahead of various charges, including stock-based compensation. This comes after the business was solidly profitable on a far smaller revenue base not that long ago.
The observation and a relatively manageable $164 million net debt load made me quite cautious, given the disappointing earnings power in relation to sales. This was the case when shares traded at $32 per share in September as the momentum in the sector was not very good.
Coming Down
Since September, shares of Ultra Clean have fallen from the $32 mark to the $25 mark, having lost over 20% of their value in the time frame of just two months.
Towards the end of October, the company pre- announced its third quarter results. While the company guided that third quarter sales should come in at, or above, the midpoint of the guidance of $430 million, the same cannot be said for earnings. The issue is that adjusted earnings of $0.04 per share are seen as much lower than a previous $0.08-$0.28 per share guidance due to lower volumes, inefficiencies, and adverse changes in the business mix.
Days later, Ultra Clean reported third quarter sales at $435 million, which is a near 32% reduction from the same period last year, although that revenues trend flattish on a sequential basis. With GAAP operating profits posted at $5 million, a net loss of $14 million (or $0.32 per share) was reported. Adjusted earnings were reported at four pennies, while net debt came in at $139 million following sound net working capital conversion.
While the earnings numbers were softer than anticipated, it was the fourth quarter outlook which inspired some confidence. Sales are seen between $420 and $470 million, at the midpoint suggesting modest improvement in sales to $445 million. Adjusted earnings are seen between $0.02 and $0.22 per share, still resulting in modest GAAP losses.
With 45 million shares trading around $25 per share, the market value of the firm has fallen to $1.12 billion, for a $1.26 billion enterprise valuation. With sales trending at $1.75 billion, the company trades at a mere 0.7 times the sales multiple, albeit that realistic earnings are still not to be found.
A Bolt-On Deal
Despite the lack of current profitability, Ultra Clean announced a deal to acquire HIS Innovations Group, a supplier to the semiconductor sub-fab segment. The company believes that the deal will expand the addressable market by one and a half billion, with 60 subs being developed across the globe.
The deal calls for a $50 million upfront cash component, as well as another $50 million cash earn-out depending on the EBITDA performance in fiscal 2023. Based on this $100 million deal tag, the company communicated that it pays an 8.3 times multiple, suggesting an EBITDA contribution of around $12 million.
If the earn-out for 2023 is not fully achieved, up to $20 million might have to be paid out in 2024 and 2025, depending on the achievement of the results at those points in time. Needless to say, with a $57 million revenue contribution, this is a more expensive deal, but it is clear that HIS is much more profitable, as the look looks quite accretive.
In the conference call, it became clear that HIS is expected to contribute about $10 million in revenues to the upcoming quarterly results, and adjusted for that the sequential revenue growth has come to a complete standstill.
What Now?
The truth is that I believe that Ultra Clean is a mixed bag at this point in time. Shares have come down quite a long way from September, and while revenues came in largely in line with the expected performance, margins were soft, as the same more or less applies for the fourth quarter. That said, shares have come down a bit as the deal for HIS looks quite interesting.
Nonetheless, the same situation more or less compares to September. The company is still not really profitable, but this is not a great point in the cycle, although that leverage seems to be controllable even post this bolt-on deal.
Amidst all this, I am turning more upbeat on the shares, merely for the fact that shares have come down another 20% since September, although I don't have the conviction to initiate a position (in size).
For further details see:
Ultra Clean Holdings: Muddling Through