ams AG (OTCPK:AMSSY) (AMS.S) has given investors quite the ride over the last year or so, with the shares still down over 50% over the past year (far below the almost flat performance of the SOX), but up more than 60% since the time of my last article on a better first quarter, strong guidance for the second quarter, and several content wins in the Android smartphone market.
I don’t really expect trading in ams shares to really be any calmer any time soon. Not only are there risks to Apple (AAPL) volumes from the next phone cycle (which will begin later in 2019) and another possible inventory correction, but there’s still uncertainty about exactly which components ams is winning with these Android vendors, not to mention what those volumes will look like. On top of that, there’s still meaningful uncertainty about the pace of the recovery in demand for auto and industrial markets, and oh by the way, also ongoing competitive risks as companies like STMicro (STM), Sony (SNE), and Infineon (OTCQX:IFNNY) try to elbow their way into the 3D sensing market.
A Stronger Q1, With Much Stronger Guidance
ams didn’t report particularly robust first quarter results, but Wall Street is driven by expectations, so “better than expected” is still a win of sorts.
Revenue declined 7% yoy on a like-for-like basis, and about 20% on a sequential basis, which was still good for a 7% beat. The industrial and auto business actually outperformed on a relative basis, up 10% yoy and down 6%, with consumer down 14% yoy and 26% qoq. As Apple is still the bulk of the consumer business, you can draw your own conclusions about the primary driver to ams’s weaker quarter.
Gross margin held up reasonably well, but there was definitely erosion, with margin down 360bp year of year and 310bp quarter over quarter, but that was still a nearly four-point beat relative to expectation. Operating income was much weaker, down 67% yoy and 62% qoq, with over 11 points of year-over-year contraction and over six points of sequential contraction, but ams still beat by more than three points.
Guidance was particularly encouraging for the next quarter, especially in a quarter where many chip companies talked down expectations for the second quarter. With several Android projects ramping up, ams lifted revenue guidance to a range of $390 million to $430 million, with the midpoint about 14% above the sell-side average going into the quarter. Management also guided to a substantially higher adjusted operating margin (11% vs the sell-side average estimate of 1%).
Android Helping, But Apple Still Matters A Lot
Specifics are almost always lacking when it comes to chip companies and phone wins, but ams has logged multiple wins for 3D-related illumination (VCSELs) for front- and world-facing cameras with vendors in Korean and China, including Samsung and Huawei. These wins seem to include VCSELs, optics, and proximity sensors across multiple sensing technologies (time of flight and active stereo), but it doesn’t sound as though ams is winning as much content on the image sensor side. At this point, then, it would seem that ams is picking up some share in VCSEL, maybe at Lumentum’s (LITE) and II-VI’s (IIVI) expense, but these are still early days for the entire space.
ams has also been logging some initial wins in a new behind-the-display light sensor for phones with OLED screens. These wins are with Android customers and they allow for bezel-free designs, and apparently they offer fairly attractive economics to ams at this point.
The progress ams has made with Android OEMs is encouraging, but there’s still a lot left for the company to do. Winning more sensor content would be a significant positive, and it remains to be seen how competitive the company’s offerings in ToF really will be (structured light has been their area of strength so far). At the same time, companies like STMicro, Infineon, and Sony have made no secret of their interest in capturing share and content in this market.
As far as Apple goes, that OEM remains a major customer for ams, as Apple’s structured light face ID feature is the biggest commercial opportunity today for ams’s structured light offerings. Everybody knows the last generation of new iPhones disappointed, and we’ll see how this next generation goes. Success with Apple, both in terms of content per phone and handset volumes, is still a key part to ams hitting the sell-side’s targets, with Apple likely to account for about two-thirds of the company’s second-half growth.
I liked ams’s JV agreement with Wise Road Capital for the environmental, flow, and pressure sensor business announced back in late March. While the market opportunity for these sensors is attractive (even with Sensirion enjoying strong share in many of these segments today), the opportunities in 3D sensing in consumer, industrial, and auto markets are larger, and ams doesn’t have the resources to do it all. While the 3D sensing space is more crowded and competitive, the potential rewards to ams for being a successful 3D sensing components supplier are considerably larger than for those other sensing businesses.
Modeling always involves guesswork, but that’s even more the case with a company like ams where the primary served markets are themselves just getting started. How far 3D sensing will extend beyond the highest-end phones is an open question, as is the preferred technology, the preferred vendors, and the specific component wins (ams may continue to do well in VCSEL, for instance, but be elbowed aside by others like STM or Sony in sensors).
That said, I’m modeling high single-digit long-term annualized revenue growth for ams, with the bulk of that in the near term being driven by 3D sensing adoption in handsets. Wider use in industrial and auto applications (LIDAR especially) is a meaningful longer-term driver. I believe the reliance on phone OEMs and the fierce competition in the 3D space will limit some of ams’s margin leverage, so I am expecting only mid-to-high teens adjusted FCF margins over my forecast period (many chip companies can get into the 20%’s). To that end, I’d also note that my relatively modest near-term outlook (over the next two to three years) for gross and operating margin leverage is a limiting factor on valuation.
The Bottom Line
While the current/near-term margins can’t drive a particularly attractive fair value, and there’s a limit to how far I’ll go with the “project ahead, discount back” methodology, the shares do still look undervalued on the basis of cash flow, with the shares pricing in a low double-digit annualized return even after this big run. ams continues to offer well above-average risk, but the company does seem to be logging the hoped-for design wins. I’m reluctant to chase this rally right now given some weakness in the sector, but this is still a name worth considering for its longer-term potential.
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.