ams-OSRAM Stock Hammered On Near-Term Performance And Long-Term Doubts

Writing about ams-OSRAM (OTCPK:AMSSY) in March, I was concerned about the risk that weaker near-term results would overshadow the company’s efforts to reposition its technology toward higher-growth long-term opportunities. I underestimated just how weak that near-term performance could be, though, and it seems that the Street is unwilling to give this company any real benefit of the doubt at this point – a situation that I argue the management team has earned.

These shares have fallen another 45% since my last article, dramatically underperforming the SOX over that time. Although these shares don’t look expensive at this point, the impact of losing 3D sensing business at Apple (AAPL) and a lack of traction thus far in other growth projects makes for a challenging buy call. I do see opportunities for ams to be a stronger company (and stock) in the future, and I like the idea of buying in at a price where sentiment is ugly, but investors considering this name need both high risk appetite and patience.

Noticeable Weakness In The Current Operations

Expectations weren’t particularly high for ams this year, but the company has still come in with weaker than expected results, with first and second quarter revenue numbers that were more than 10% below initial sell-side expectations for the year. Perhaps not surprisingly, margins and profits have also come in below expectation, as ams has seen cost input/supply chain pressures and disappointing operating leverage.

The last quarter saw revenue rise 2% year over year on an adjusted basis and decline more than 3% on a sequential basis, with core semiconductor revenue up just 1% both yoy and qoq. Benchmarking ams is a challenge, as companies like STMicro (STM) only partly overlap the company’s business/product lines, but the reality is that ams’s performance is weak by almost any comparable standard, with legacy verticals like auto also underperforming.

Gross margin fell about two points in the second quarter (to 31.6% adjusted), while operating income fell about 5% on an adjusted basis, with adjusted margin declining 60bp yoy to 8.8%. Margins are still meaningfully better in the semiconductor business (around 12%), but in this case “better” is still rather poor, as low-to-mid teens margins are quite uninspiring for a semiconductor company.

Waiting For New Opportunities… And The Wait Goes On

It’s no great stretch to say that the market remains completely unconvinced that the acquisition of OSRAM will prove to be a value-creating deal for ams. While there are credible opportunities to combine ams’s expertise in areas like emitters, detectors, and drivers/interfaces with OSRAM’s lighting technologies, the reality is that the core of OSRAM’s business remains unexciting from both a growth and margin perspective. Likewise, the market has not reacted particularly well to the loss of significant 3D sensing-related business at Apple, as it has sapped the primary driver of ams’s business growth.

The company’s analyst day earlier this year was an opportunity to reset expectations and reassure the Street about the growth strategy, but a quick look at the share price performance shows that investors are not at all confident about this strategy, or management’s ability to execute.

One thing I found particularly interesting about the presentation was that the company really wasn’t talking up its opportunities in smartphone-related 3D sensing. I’ve heard from several investors hopeful that ams could someday win back Apple’s business, but it looks like phone-based 3D sensing is less of a focus now. Given difficulties in making inroads with other OEMs, and ongoing delays in the adoption of behind-OLED (or BOLED) sensing, that makes sense.

To be clear, ams isn’t abandoning this area, but management no longer seems to be tying their growth expectations to it, and that seems reasonable. Instead, management is pointing more toward other opportunities based on core technologies including improved color sensing and camera performance.

This leaves ams in a position where it is trying to sell investors on emerging opportunities that take advantage of the company’s expertise in emitting, detection/sensing, and integration.

I’ve talked about the opportunity in microLEDs before, and I continue to believe this is a significant opportunity over the next five years for ams, with management sizing an addressing market opportunity of around $4.5B based on smart devices, TVs, AR/VR, and dashboards. Management has also been talking up the potential for integrated emitting/sensing solutions in med-tech, including vital signs monitoring and endoscopy.

Last and not least are growth opportunities tied to OSRAM’s legacy position as a supplier to auto OEMs. In-cabin sensing (driver/passenger monitoring, gesture sensing, et al) is, in my view, an underappreciated opportunity and one that plays to ams’s capabilities in integrating emitting and detecting capabilities. But it’s also an unproven market opportunity and given the price premiums for electrified power trains, advanced driver assistance systems, and so on, it remains to be seen how quickly OEMs can add these features before sticker shock becomes a problem (and likewise, how much they’ll lean on suppliers where pricing is concerned).

The Outlook

The last five or six months have seen some sizable hits to management’s credibility with investors and its standing with analysts – 40%-plus share price declines don’t just happen for no reason. Along those lines, while there were always expectations that ams would face challenges from OSRAM divestitures, lost 3D sensing business, and supply chain issues across its served markets, I haven’t seen or heard a good explanation from management as to why they’re faring so much worse than the “average” chip company serving similar markets.

In keeping with the weak results seen to date (and management’s short-term guidance), I’ve slashed my near-term full-year revenue estimates by about 15% to 25%, and likewise cut back my expectations for margins and free cash flow generation fairly significantly. From these changes come far, far lower long-term growth expectations – only about 1% for revenue and around 2% for FCF. In an attempt to adjust for the business reset going on at ams, re-running those growth rates with my estimated FY’22 numbers as starting points leads to a 4% long-term revenue growth rate and a much higher FCF growth rate.

The Bottom Line

Right now, ams looks like it is in a valuation and sentiment “no man’s land”; current results do not inspire confidence, and investors are understandably skeptical about management’s ability to deliver on these more speculative future drivers.

That horrible sentiment is amply reflected in the share price insofar as I can see, but I’ve learned over the years that companies can surprise in both directions, and the situation at ams could certainly get worse before it gets better. That said, a lot of negativity already seems baked into the share price and provided that ams can achieve EUR 4.4B or better in annual revenue and better than mid-single-digit operating margins over the next couple of years, the shares do look undervalued and maybe appropriate for a high-risk dumpster-diving expedition.