2023-10-19 06:28:59 ET
Summary
- Vicor Corporation's stock is currently trading significantly lower than its all-time highs, but it is still massively overvalued.
- The company has shown solid momentum in profitability improvement due to a more favorable sales mix with cutting-edge products.
- Vicor's financial performance has been volatile, and more quarters are needed to determine if profitability expansion is sustainable.
Investment thesis
Vicor Corporation's ( VICR ) stock has been hot during the 2021 stock market frenzy but currently trades about three times lower than all-time highs. Despite trading way below historical highs, the stock is still massively overvalued, according to my valuation analysis. This might be due to the fact that VICR experiences solid momentum in profitability improvement due to a more favorable sales mix with more cutting-edge products dominating the total pie. On the other hand, the company has a rather volatile history of financial performance, and I need a few more quarters to understand whether profitability expansion is sustainable or if it is just another big swing in the company's unstable financial track record. That said, I assign the stock a neutral "Hold" rating.
Company information
Vicor designs develops, manufactures, and markets modular power components and power systems for converting electrical power.
The company's fiscal year ends on December 31. VICR categorizes its offerings into Advanced Products [AP] and Brick Products [BP]. APs represent the company's most innovative products using VICR's cutting-edge proprietary distribution architecture, while BPs largely consist of integrated power converters used in conventional power systems. According to the company's latest 10-K report , AP represented 61% of the total revenue in FY 2022.
Financials
Over the past decade, the company demonstrated an impressive 8% revenue CAGR and solid gross margin consistently above 40%. As the business scaled up, VICR delivered a notable operating margin expansion from about -10% ten years ago to 8.4% in the last full fiscal year. However, it is important to underline that over the last five years, the operating margin has been very volatile. Despite having an improved operating margin over the long term, the free cash flow [FCF] margin is still very unstable and frequently below zero due to the capital-intensive business model. Over the last three years, VICR invested about $140 million in capex, which is approximately 14% of the total revenue over the same period.
Having a consistently negative ex-SBC FCF margin does not allow the company to return money to shareholders. Thus, VICR neither pays dividends nor conducts stock buybacks. According to the company's cash flow statement , there was a massive $121 million issuance of common stock, which enabled it to build up a solid balance sheet with very low leverage and strong liquidity metrics.
Seeking Alpha
From the long-term perspective, the company's strong balance sheet could have been a big positive sign for investors, but we should not ignore the context. The source of the strong balance sheet was the issuance of new stocks and not from wide operating profitability. I do not like that profitability metrics have also stagnated in the last couple of years. On the other hand, the company invests heavily in innovation, with R&D to revenue ratio consistently above 15% over the past decade. Having a firm commitment to innovation is a good sign for investors, which might indicate the management's long-term mindset.
Now, let me switch to recent developments. The latest quarterly earnings were released on July 25, when the company topped consensus estimates. Revenue grew by 4.5% YoY, which looks decent amid the current high level of macroeconomic uncertainty. The gross margin expanded substantially YoY from 45.9% to 51.7% due to the more favorable product mix. AP revenue increased YoY by 31.6%, while the BP's sales decreased by 15.7%. Strength in the gross margin allowed the company to expand the operating margin accordingly.
The upcoming quarter's earnings are scheduled for release on October 24. Quarterly revenue is expected by consensus at slightly below $107 million, which indicates a 3.8% YoY growth. The adjusted EPS is expected to expand notably from $0.18 to $0.34. That said, the solid momentum for profitability expansion is expected to be sustained over the near future at least.
It looks like the company's substantial investments in R&D are starting to pay off since there is massive growth in AP revenue, which improves the revenue mix and allows it to expand profitability metrics. Consensus earnings estimates expect the EPS to more than double in the upcoming three years, which is a strong bullish sign. As the level of global digitalization increases, especially with the increased penetration of electric vehicles and artificial intelligence, the need for more efficient power components is an inevitable consequence. VICR is well-positioned here since the company's substantial investments in R&D allowed the company to expand its intellectual property portfolio. As of the FY 2022 year-end, the company had issued 122 patents with expirations scheduled between 2023 and 2040. The improvement of the product mix also suggests the company is moving in the right direction from the technological perspective. On the other hand, a long-term track record of financial performance has been volatile, and I need to look at how the next few quarters will unfold to get more conviction that the growth and profitability expansion is sustainable.
Valuation
The stock price appreciated 1.3% year-to-date, significantly underperforming the broader U.S. market. Seeking Alpha Quant assigns the stock a deficient "D-" valuation grade, indicating a substantial overvaluation based on multiples. Indeed, most part of the company's valuation rations are multiple times higher than the sector median. On the other hand, current multiples look attractive compared to historical averages.
Ratio analysis gives me mixed results, so I must expand my valuation with the discounted cash flow [DCF] model simulation. I use a 10% WACC for discounting. I have revenue consensus estimates for the upcoming three years and project a long-term 8% CAGR for the years beyond. This aligns with the revenue growth over the past decade and looks fair enough. I expect a zero FCF margin this fiscal year with a one percentage point yearly expansion starting from the next year.
From the above calculations, we can see that the stock is substantially overvalued. Even under moderate assumptions, my DCF suggests that the business's fair value is approximately $1.3 billion, which is way lower than the current market cap. That said, the stock's fair price is approximately $30.
Risks to consider
According to the latest 10-K report, VICR generated approximately 19% of the total revenue from customers located in China and Hong Kong. That said, the company faces substantial geopolitical risks in light of tensions between the U.S. and China, which were escalating in recent years. The technological race between the world's two largest economies is the major reason for geopolitical tensions. As a result, the U.S. has banned exports of cutting-edge technological products to China in recent years, and the list of products not allowed for export is still expanding . If the U.S. authorities ban some of VICR's offerings for export to China, this is highly likely to be a massively adverse event for the company.
Apart from potential export bans, which I consider to be a remote risk but with massive adverse impact, there are a couple more risks related to significant international trade activities. Having a substantial portion of revenue generated outside of the U.S. exposes the company to significant international regulations and tariff risks as well as foreign exchange risks.
Bottom line
To conclude, VICR is a "Hold". Despite demonstrating solid profitability expansion momentum, my valuation analysis suggests that vast optimism is already priced in. I like the management's commitment to innovation and heavy investments in R&D. Still, the long-term financial performance history has been rather volatile, and the FCF margin is razor thin. I need a few more quarters to get more conviction that VICR is now on a sustainable path of profitability expansion.
For further details see:
Vicor: Solid Profitability Expansion But Vast Overvaluation