Advanced Energy Industries Q2: Slow Progress; Worst Is Likely Over

Once I final wrote about Superior Power Industries (NASDAQ:AEIS), I stated that I anticipated Q1’24 to be the low level of the cycle for this provider of energy conversion and management methods, and that also seems to be the case. That stated, key segments like Industrial are nonetheless seeing destocking and the rebound in semiconductor demand doubtless will not actually hit till 2025. That leaves AEIS in one thing of a grey space because the enterprise crawls alongside within the close to time period, however nonetheless gives enticing to leverage to more and more elaborate semiconductor manufacturing calls for, industrial electrification, and knowledge middle capex.

AEIS shares have risen about 10% since my final replace, even with a post-earnings selloff. Benchmarking that efficiency is just a little difficult as the corporate does not have a variety of “apples to apples” comps, however Delta Electronics (OTCPK:DLEGF) (2308.TW) has outperformed, whereas Comet (COTN.SW), MKS Devices (MKSI), and XP Energy (OTCPK:XPPLF) (XPP.L) have underperformed over that very same interval.

At this level, AEIS continues to be a considerably difficult suggestion. I just like the leverage the corporate gives to extra elaborate deposition and etch steps in semiconductor manufacturing (by means of main prospects like Utilized Supplies (AMAT) and Lam Analysis (LRCX)), and I just like the longer-term alternatives in industrial electrification, medical gadgets, and knowledge facilities, however the firm has much more to show in these latter markets. I nonetheless lean “purchase” right here, however that could be very a lot predicated on a significant ramp in income and margins over the following 12 months.

Blended Outcomes In opposition to A Decrease Bar

AEIS did report higher than anticipated outcomes for the second quarter, however the outcomes have been in-line to down relative to expectations initially of the 12 months – in different phrases, the corporate beat a bar they lowered after Q1 earnings, however total efficiency continues to be trending weaker than what analysts and administration anticipated initially of the 12 months after This fall’23 earnings.

Income declined 12% 12 months over 12 months however did return to sequential progress (up 11%) this quarter, beating expectations by <1% to round 4% relying upon which estimate reporting service you employ.

Income from the Semiconductor section was up 9% yoy and 5% qoq, beating expectations by about 3% and that is the one enterprise that’s monitoring fairly near preliminary expectations for the 12 months, despite the fact that demand outdoors litho tools actually hasn’t hit its rebound stride but. Within the Industrial enterprise, AEIS continues to see painful destocking (and weaker end-user demand, I imagine), with income down 38% yoy and 5% qoq, lacking by round 5%. Knowledge Heart rebounded properly, up 24% yoy and 74% qoq and beating by greater than 10%, however there was a notable push out from Q1. Lastly, the Telecom/Networking enterprise stays tough, down 56% yoy however up 10% and barely higher than anticipated, however accounting for lower than 7% of income.

Gross margin declined 30bp yoy and improved 20bp qoq to 35.3% (non-GAAP), beating by about 30bp and helped by the stronger Semi and Knowledge Heart outcomes. Working revenue declined 31% yoy and rebounded 57% qoq, beating by 23%, with margin down 260bp yoy to 9.3% and up 270bp qoq, beating by 150bp.

A Lot Of Uncertainty Over The Timing Of The Restoration Stays

Administration’s steering for Q3’24 didn’t present the form of robust affirmation that the worst is over, and the rebound has begun that the Road needed (and arguably wanted) to listen to. The income information calls for under a modest sequential enchancment in income (about 1%) and was modestly beneath Road expectations, as a return to sequential progress in Industrial might nonetheless be 1 / 4 away (and a extra significant upturn might be extra of a mid-2025 occasion).

Administration’s EPS steering was additionally lower than reassuring. Whereas the midpoint of $0.90 was certainly a bit above the Road’s prior estimate ($0.88), the unfold of +/- $0.25 would appear to mirror a variety of uncertainty about volumes, product combine, and the near-term advantages of producing effectivity efforts (together with manufacturing facility consolidation). To be truthful to administration, there’s little to be gained from creating a synthetic sense of precision, however it does underline the still-shaky and unsure nature of the restoration at this time limit.

Higher Days Lie Forward, However Execution Stays A Key Unknown

Nonetheless the most important enterprise for AEIS, I’ve the least considerations concerning the pending restoration within the Semiconductor enterprise. Whereas semiconductor inventories do nonetheless stay too excessive, this is not a everlasting scenario and I do count on capability progress to choose up subsequent 12 months, driving demand for extra (and extra refined) deposition and etch tools.

As semiconductor manufacturing will get ever extra refined and demanding, the necessity for extra exact energy management grows. With newer merchandise like eVerest and eVoS approaching and alternatives to realize share in areas like dielectric etch, I imagine a number of years of double-digit progress on this enterprise beginning in 2025 is an affordable expectation.

With Industrial, the difficulty is not the dimensions of the chance, however administration’s skill to execute. I just like the long-term alternative to learn from drivers like industrial electrification (significantly by means of check & measurement and movement management/robotics) and the expansion of ablation within the medical system house, however AEIS has lengthy struggled to execute outdoors of its core semiconductor markets and the corporate nonetheless must show that it may possibly develop the merchandise wanted to seize and maintain share within the extra enticing segments of the market.

So too with Knowledge Heart. Underlying demand progress is not the difficulty – knowledge middle capex stays sturdy and knowledge middle energy calls for proceed to scale larger (significantly for knowledge facilities dedicated to AI). The problem, as with Industrial, is displaying that it may possibly compete successfully in opposition to entrenched suppliers like Delta and win share for high-value/high-margin options.

Contemplating that context, it is value mentioning the corporate’s try to amass XP Energy earlier this 12 months. Though AEIS provided a wealthy premium, XP Energy had no real interest in even discussing the bid, and AEIS moved on. I am not solely positive what to make of the corporate’s method, although.

On one hand, XP Energy’s break up between semiconductor (round one-third of income), industrial (over 40%), and medical (over 25%) has apparent synergy, and the gross margins right here have been respectable (low-40%’s). Then again, in some unspecified time in the future, AEIS has to point out that it may possibly compete successfully by means of inner product improvement and take away market share from established rivals. The extent to which this was an opportunistic bid versus an acknowledgement that the portfolio is not the place it must be is the foremost uncertainty for me, although I lean extra towards believing this was an opportunity so as to add a helpful portfolio of belongings at an interesting worth versus an acknowledgement that the AEIS Industrial enterprise is not aggressive sufficient by itself.

The Outlook

I’ve pulled again my expectations for FY’24 and FY’25 a bit, totally on a weaker outlook for the Industrial and Telecom/Networking segments. I nonetheless have some considerations about actual end-user demand in a number of industrial markets and as studies from firms like Ericsson (ERIC) affirm, circumstances in telecom capex are nonetheless actually weak.

I am nonetheless on the lookout for a major rebound in FY’25 (income up 17%), with double-digit follow-through in FY’26 and FY’27 (the latter could also be a bit bold). Long run, I am nonetheless on the lookout for annualized income progress of between 5% and 6%, lower than half of the trailing progress price.

I count on this 12 months to be the underside for margins as properly, with gross margin enhancing about 4 factors over the following two years and working margin enhancing greater than six factors on higher leverage. On the free money move line, I count on enchancment again into the mid-teens over the following three to 4 years and low double-digit long-term progress.

So far as valuation goes, I count on excessive single-digit long-term annualized appreciation primarily based on discounted money move. Multiples-based approaches are tougher, as weaker near-term efficiency drags down the obvious truthful worth. I believe a good worth within the $110-$120 vary is affordable primarily based on margins over the following 12 months, but when and when the rebound reveals within the numbers and the Road positive factors extra confidence round a margin restoration in FY’25-FY’27, a good worth within the $130’s turns into extra believable.

The Backside Line

Being bullish on AEIS right now requires confidence that the semiconductor tools market will strengthen in 2025 (and past), knowledge middle capex will stay robust, and industrial demand will rebound in 2025, in addition to confidence in administration execution. I am assured concerning the market outlooks, however administration’s skill to drive enhancements in market share, combine, and margin are nonetheless extra within the “potential” column for me.

I do nonetheless see sufficient upside to stay bullish, however I need to emphasize once more that that is an execution-driven story, even with underlying market rebounds creating tailwinds over the following 12 months.