ACM Research: What Investors Should Pay Attention To In The Q1 Results

Summary

• ACMR delivered on its promises and posted close to 19% quarterly revenue growth even despite the pandemic.
• It is still exceptionally bullish on the 2020 revenue prospects, predicting sales to rise 21.0%-39.5%.
• I was partly right on the Wuhan issues; in March, investors factored in this risk, and the share price plummeted to the 10s.
• I remain neutral, as positives and negatives are nearly equally weighted.

On May 6, ACM Research, Inc. (NASDAQ:ACMR), a semiconductor capital equipment manufacturer, presented its first-quarter results. The figures were generally robust, especially the top line, even despite the COVID-19 pandemic that began in the Wuhan province of China where ACM's principal customers like Yangtze Memory Technologies (or YMTC) operate.

I brought the company to the attention of my readers in late-January. Back then, I pointed out the Wuhan risk was not priced in, or, put another way, the possibility that its essential customers would defer or cancel growth plans and suspend purchases of capital equipment was high. In this sense, investors' sentiment could swiftly change from reckless bullishness to outright bearishness. Among other things, ACM has a high customer concentration (three customers brought almost 74% of the 2019 revenue), and if one client suspends purchases/shipments due to lockdowns or other coronavirus-related headwinds (e.g., the semiconductor market woes), the total sales will be afflicted. If the market realized how serious risks truly were, ACMR lofty valuation (e.g., ~36.8x Forward EV/EBITDA) would evaporate abruptly. As the situation with the COVID-19 was fluid, I remained neutral.

In February and March, my prognosis materialized, as ACM share price shrunk more than 2x. But since then, a gamut of catalysts, including Q1 EPS and revenue beat, lifted the price to an all-time high. Now, I believe it is worth reassessing the stock.

The top line

Thankfully, despite the raging pandemic that severely hit China and then spread across the globe, ACM remained relatively unscathed. Its Q1 revenue had strong momentum and rose 18.9% YoY, thanks to robust sales of front-end processing capital equipment, while shipments, a more volatile metric, slipped to $12 million vs. $25 million in Q4 and $14 million in Q1 2019. The top-line growth could be more impressive, if not for softness in back-end wafer assembly and packaging (the company did not shed light on what actually impacted back-end customers).

Data by YCharts

Despite some quarterly revenue volatility, LTM figures have also continued to climb higher.

Data by YCharts

While, in the first quarter, ACMR delivered on its promises, it also remained remarkably bullish on future revenue prospects. It reiterated the 2020 sales target of between $130 million and $150 million (a 21.0%-39.5% growth YoY), though it also remarked that the milestone is achievable only if "the COVID-19 situation continues to improve in China and stabilizes in the coming months on a global basis." At the same time, analysts are expecting the 2020 revenue to surpass $140 million.

While sales surged, margins weakened. But I am content with that. Though the gross, operating, and profit margins declined, I do not consider that as a worrisome matter, as profit instability is often inherent to high-growth companies that are aggressively expanding their technology portfolios. Moreover, the gross margin was in the 40%-45% long-term target range, so, nothing dramatic had happened. Also, product mix, one of the key variables that influence the GM, can fluctuate over time, and it is clearly not a harbinger of a permanent decline in profitability. And, ultimately, cash flows, which are of greater importance than accounting profit, remained exceptionally robust.

Research & Development

For investors who ponder holding the stock for a few years and who want to benefit from the materialization of ACMR's ambition to become "a major player in the semiconductor equipment market," it is essential to understand how the company manages its R&D activities that are at the crux of the long-term revenue growth. In Q1, the company poured more funds into Research & Development, which I strongly endorse. R&D rose 33% to $3.68 million. Both GAAP and stock-based compensation-adjusted R&D were up; R&D as a % of revenue rose to 15.1% vs. 13.5% in Q1 2019.

However, there is an issue not evident upon cursory inspection that readers should not overlook. The gist is that GAAP R&D is highly influenced by the PRC governmental grants (see page 32 of the Form 10-Q). If we exclude the impact of the Chinese grants, GAAP 1Q19 R&D expenses were lower than in 1Q19, $3.9 million vs. $4.1 million, which, surely, does not mean the company was less active in product development.

Obviously, high R&D spending bears fruit. For instance, in April, ACM introduced the Ultra Furnace system, thus entering the dry cleaning market. In May, the offering of a suite of three Ultra™ C wet cleaning tools was announced. New product launches should help ACMR to expand the market share and successfully compete with existing players in this complicated market (like semiconductor industry heavyweight Lam Research (LRCX)). Speaking about the market share, in FY 2019, the company had slightly improved its position and increased it to 3.3% from 2.2% in 2018 (see slide 5). Though it was not a bumper change, the growth trend is apparent.

Remarks on customer mix

ACMR's sales are growing by leaps and bounds; surging revenue is pushing valuation to the extremes. But the flip side is that ACMR's customer base is still highly concentrated, which remains the principal risk worth bearing in mind.

In the recent investor presentation, it enumerated its seven key clients, on the front-end and back-end sides. Among them was Semiconductor Manufacturing International Corporation (SMIC). The firm that is among the largest chipmakers in China has recently filed for listing on the Shanghai Stock Exchange to raise around $2.8 billion. That indicates the firm is growing aggressively, and it will have no issues with coverage of capital equipment purchases, which is good for ACM Research.

Free cash flow

It is nice to see that, in the first quarter, high revenue growth was assisted by the high quality of earnings. Its operating cash flow turned positive (mostly because of lower inventory build-up and increase in accounts payable) and more than excessively covered capital investments, which changed only slightly compared to a year-ago quarter and amounted to $118,000.

Though the company delivered positive FCFE of $3.71 million, I reckon it is too premature to consider dividend distributions: it is far better to retain cash and finance expansion plans using equity, not debt.

Perfect financial position

ACM Research has an exemplary combination of a surfeit of cash and small, almost zero total debt. In the first quarter, the company's financial position even improved, as it repaid a substantial portion of short-term borrowings, and Debt/Equity fell to 2.5%.

ACMR detailed the structure of its current borrowings in Note 6 of the Form 10-Q (page 13). Among fully repaid lines of credit were lines from the Bank of Shanghai Pudong Branch, China Everbright Bank, etc.

As of end-March, the company had only three remaining lines of credit (Renminbi - and Korean won-denominated) from China Everbright Bank and Industrial Bank of Korea (IBK). All three mature in the coming months (a $1.13 million line had already matured in April). In August, ACMR's total debt might go straight to zero, if the company does not consider any other credit funding. Also, the company has a few maturities of leases liabilities in 2020 and 2021, but considering its sizable cash pile, I reckon it will have no issues.

A few capital-intensive activities are ahead (e.g., construction of a new R&D center and production facility in Shanghai starting in 2020; it had already finalized the agreement to acquire land rights), but in the quarterly report, the company did not clarify if it was considering seeking new credit lines or if it was anticipating covering opex and capex using only shareholder funds.

The valuation is approaching a zenith

At the moment, ACM Research's valuation is highly inflated, spurred by the overall bullish sentiment of the market; its 'F' Value Grade vividly illustrates that. The company's prospects have not changed since January (compare the 2020 sales guidance presented in the January press release and in the Q1 earnings release), while multiples soared to the all-time highs (if we exclude the 2018 EV/EBITDA and EV/EBIT distorted by losses). I would not say it is reasonable to consider initiating a position now when valuation is approaching a zenith.

Final thoughts

Since my previous coverage, the Wuhan risk has evaporated, as China was the first country that lifted lockdowns and (almost) returned back to normal. As the CEO Mr. Wang has clarified during the earnings call,

Since outbreak, we have been in constant contact with our customers, in particular, YMTC is the first factory and its center of operations are in Wuhan. They are fully committed to scaling production. We happily report that Wuhan has officially opened and we are on track for delivery to YMTC in the second quarter and beyond. Our other customers in less affect city have also returned to work in an ordinary fashion. Operations appear to have returned to normal.

ACMR remains a high-risk, high-reward technology stock. Among the bearish arguments are high customer concentration, tough competition, and small market share. However, the company has been undertaking measures to seize the bigger stake, pouring funds into sales & marketing and R&D, and its efforts have already been bearing fruit. Also, investing in ACMR is a rare opportunity to benefit from the Chinese semiconductor industry growth, while holding shares in the U.S.-based Nasdaq-listed company with transparent GAAP reporting. On the other hand, the recent escalation of the U.S.-China trade tensions multiplies downside risks.

As positives and negatives are nearly equally weighted, I remain neutral on the stock.

Analyst’s 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.