Ichor Holdings: Chip Spending Slowdown Provides Buying Opportunity

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About: Ichor Holdings, Ltd. (ICHR)
by: Laidy Vasquez
Summary

The company experienced a 43% growth rate over the past twelve months and has averaged near a 40% growth rate since 2015.

Ichor has managed to increase its market share due to the innovation and quality of its products and the acquisition of some companies such as IAN engineering in April 2018.

The share price is worth north of $19 based on my fundamental analysis and the revenue declines appear temporary in the semi conductor industry.

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The Opportunity

Ichor Holdings (ICHR) has a great strategy with standards of innovation and quality, that has seen the company maintain a constant growth in the fluid delivery/chipset supplier marketplace. The company has increased their cash flows, EBITDA and expanded their margins by capturing a large growth opportunity in the semiconductor industry.

The stock has fallen nearly 50% from all time highs reached at the end of January and it appears the share price was benefiting from record revenues in the semiconductor suppliers industry, which translated into higher revenues for Ichor for most of 2018. The big drop in Ichor's share price appears to be the result of a temporary slow down in spending because of a slow down in semiconductor manufacturer capital expenditures. This spending reduction is a great opportunity for investors to acquire a high growth company at a significant discount.

Business Overview

Ichor is a company dedicated to design and manufactures fluid delivery subsystems for semiconductor capital equipment. Ichor generates turnkey process equipment and complete solutions in the marketplace with value added manufacturing, these solutions are provided with complete systems integration services that enable full outsourcing of design and production requirements for non-essential equipment in the medical, aerospace, oil and gas, pharmaceutical, power generation, and other industries.

Ichor is continuing the expansion of it's capabilities, trying to offer production facilities suitable for its customers' supply chain strategies. The company has expanded into new products and new markets such as an acquisition of "IAN" that allowed the company to have a greater presence in Asia.

Ichor has central offices in Fremont, California, with factories in Oregon, Texas, Singapore, Malaysia and the United Kingdom. Its sales and engineering office is in Silicon Valley, California.

Why is the market discounting the share price?

The price to earnings ratio is below 10 times, which indicates the valuation is discounting the company's growth prospects and doesn't believe the cyclical growth story in semiconductor manufacturers. An example of this narrative is a market belief that memory pricing has peaked and the semiconductor industry is in a constant state of perfect competition. The market appears to be discounting the share price based on Q4 guidance. The midpoint of managements guidance is $0.36 and when you extrapolate that by four quarters, annual EPS would come in around ~$1.44. A ten times price to earnings ratio multiplied by $1.44 annual earnings would give you fair value for the share price at $14.44.

Valuation

Given the current share price of Ichor, I believe it is a good time to acquire shares. I derive a price target of $19, which is calculated based on a current PE ratio of 5.8 and a forward PE ratio in the range of 11 to 12 times. Sales have been temporarily declining as of Q3 because of a slow down in semiconductor manufacturer capital expenditures. The stock is trading to a 0.5 price to sales ratio, which is a distressed asset multiple. The company's sales are double its market capitalization and I believe this provides a great opportunity to pick up shares over a longer term investment horizon.

Financial Analysis

Currently, some companies in the industry are being affected by the trade war with China. In the specific case of Ichor, most of it's customers have manufacturing facilities in China and are affected by the tariffs enacted by President Trump. The company has been indirectly harmed by tariffs because Ichor's customers have reduced capital expenditure spending in semi conductor space.

The company's guidance for Q4 2018 is for revenue to decline in the low teens ~13% and continue to manage their cost structure to be aligned with the their customers’s demands in this way respond quickly. The company's dynamic cost structure is a good thing since spending can fluctuate significantly in the industry.

Jeff Andreson

Now I will turn to the fourth quarter guidance. Our forecast is for revenues in the range of $140 million to $150 million. Given these revenue levels, we expect our earnings per share will be in the range of $0.32 to $0.40. At these revenue volumes, we expect to maintain gross margins close to the Q3 level while we continue to reduce operating expenses.

Our EPS forecast also reflects a slightly lower effective tax rate and a lower fully diluted share count of approximately 23.2 million weighted average shares outstanding for the fourth quarter. Just to clarify what Tom said earlier, our sequential Q4 revenue declined at the midpoint of 17% and is consistent with other leading subsystem and component suppliers to the semiconductor capital equipment OEMs. At the midpoint of our Q4 guidance, we expect full year 2018 revenue to increase 26% as compared to 2017.

Q3 2018 Conference Call

The company also has plans focused on adding capacity to support their revenue growth initiatives. For 2019, Ichor will increase their market share and increase revenue by $100 million with gains in areas like precision machining, chemical delivery and gas panels and welding applications.

For the third quarter revenues were $175 million, decreasing 30% over the second quarter as a result of the negative effects of the trade war on Ichor customers. However, Ichor continues to manage the expansion of its market through acquisitions and alignment with the needs of its customers. The company shows a continued growth of sales which will overcome any near term effects of the trade war and maintain its growth objectives over a longer period of time.

Operating expenses decreased from $12.7 million to $11.3 million, or 11.4% in the third quarter due to cost containment measures initiated in June. Cash for the third quarter was $33 million, down $30 million, primarily as a result of share repurchases made in the quarter. The company rewards shareholders through the repurchase of shares. During Q3, the company repurchased $30 million of stock. The company has repurchased $60 million of shares and reduced the diluted share count by nearly 2 million shares YTD.

The free cash flow was negative in 2017 because of a back-end loaded revenue in Q4. Cash flows began to materialize in 2018 because of increased cash collection from Q4, 2017. Capital expenditures totaled $2.6 million compared to $6.6 million in the previous quarter, while Unlevered FCF is increasing for the year 2018.

Total debt shows an increase from the second half of the year, given the greater use of its revolving credit line, bringing total debt to $195 million for the third quarter and the total annual Debt/EBITDA ratio at 1.9, which according to the company's standard level of indebtedness.

The peer group I used to compare Ichor is composed of (AEHR) AEHR Test Systems , (AOSL) Alpha and Omega Semi, (IMI) Intermolecular Inc and (INTT) inTEST Corporation. The reason I selected these companies is they have a smaller market capitalization compared to traditional peers (AMAT) and (LRCX) and they provide a better comparable analysis than the larger peers.

Ichor's trailing price to earnings ratio is in a downward spiral, as the company missed on Q3 revenue at $175 million, compared to Q2 revenue of $249 million. This may be a temporary occurrence, as spending in the semi conductor space is undergoing a slowdown. If capital spending resumes at levels seen earlier in 2018, the company is extremely undervalued at current share prices.

The Takeaway

Ichor has experienced some negative industry trends as of late and the slowdown in semiconductor spending has caused the stock to drop by nearly 50% since late January. The company will continue increase market share in the semi conductor manufacturer supplier space, as they provide extremely differentiated products in fluid delivery subsytems. The market is discounting the fair value of the company, therefore, Ichor represents a good opportunity to acquire shares because even with the drop in sales the annual growth rate is still nearly 43% over the last twelve months.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.