Emcore Corporation Could Be An Opportunity At This Point (NASDAQ:EMKR)

It’s not easy bringing up EMCORE Corporation (NASDAQ:EMKR). Many have turned their nose up at EMKR for the way it has performed. The value of the stock has been sliced in half this year after an unexpected turn of events at EMKR, something that will take time to fix. Still, there’s a saying that it is darkest before dawn. That could be the case for EMKR. Why will be covered next.

EMKR may have left the worst behind

The chart below shows how EMKR has taken major damage. However, there are some optimistic signs amid the rubble. The stock is no longer declining the way it used to earlier. Recent price action suggests the stock has stabilized and maybe getting around to turning the corner. In fact, the stock has outperformed lately with the stock holding steady when most have fallen.

For instance, EMKR appreciated by 1.6% last week, which also helped it move past the 20-day moving average. In comparison, the SPDR S&P 500 (SPY) lost 2.4% and the Invesco QQQ Trust (QQQ) lost 4.4% during this timeframe. For EMKR to post gains in what was a tough week for stocks is noteworthy.

The stock is still far away from closing above the 50-day moving average, a bullish sign. Still, the stock is likely to get there if it keeps doing what it has been doing, which is going sideways. The fact that the stock has stopped falling and has begun outperforming can be seen as signs that EMKR may have left the worst behind.

Why EMKR has fallen down

Nevertheless, the stock has lost 47% YTD and there’s a reason for this. Earnings matter and EMKR had some bad news to share. While the Q1 FY2022 numbers were still mostly okay, the outlook was not. Guidance calls for Q2 FY2022 revenue of $32-34M, a sequential decline of 21.9%. Q2 tends to be the weakest quarter of the year, but the extent of the decline was a surprise.

Management explained why guidance was much worse than expected. EMKR is heading for an inventory correction. There was inventory building at a customer, which will negatively affect demand in upcoming quarters, possibly until the end of 2022. From the Q1 earnings call:

“we’ve conducted extensive customer and channel checks to try to understand FY ’22 demand to us, and determine the true amount of inventory in the channel. It’s clear to us that a substantial amount of transmitter inventory is tied up in the channel, probably due to competitive positioning between our customer at one MSO.

From what we can gather today. We should expect this to clear out by around the end of the calendar year. I would remind everyone that Cable TV is notoriously cyclical, and the CATV boom that was driven by COVID lasted nearly two years, now requiring an inventory correction.”

A transcript of the Q1 FY2022 earnings call can be found here.

EMKR is also dealing with other headwinds. For example, the supply chain is still giving EMKR problems. COVID-19 continues to disrupt.

“The same sort of unpredictable logistics challenges we saw in Q4 remained with us in Q1 causing pushouts in material. We expect to see these problems persist going forward. And don’t see a catalyst to drive predictability into the supply chain and short-term, we are temporarily moving to increase safety stock levels.”

Inflation is also having an impact on EMKR. Prices for, for instance, semiconductors are going up and that is finding its way back to EMKR. Margins were affected by these higher costs.

Guidance overshadowed gains elsewhere

Q2 guidance trumped the Q1 numbers, which were not that bad. Top-line growth surpassed expectations, although the bottom line fell short. Q1 revenue increased by 26.4% YoY to $42.2M. Broadband accounted for $32.3M and the Aerospace & Defense segment contributed the remaining $9.9M. GAAP EPS declined by 25% YoY to $0.06 and non-GAAP EPS increased by 27.3% YoY to $0.14. Adjusted EBITDA was $6.3M in Q1 FY2022, up from $4.4M in Q1 FY2021.

It’s worth mentioning that the GAAP numbers were negatively impacted by a charge of $1.4M for severance costs due to the shutdown of manufacturing facilities in China. In addition, the GAAP numbers were weighed down by $1.1M in stock-based compensation expense. Both are excluded from the non-GAAP numbers, which explains most of the difference between GAAP and non-GAAP earnings.

There were some smaller charges associated with the ongoing CATV transition such as the loss on the sale of some assets, some litigation-related expenses, and losses due to fluctuations in foreign exchange rates. The table below shows the numbers for Q1 FY2022.

(GAAP)	Q1 FY2022	Q4 FY2021	Q1 FY2021	QoQ	YoY
Revenue	$42.236M	$43.954M	$33.426M	(3.91%)	26.36%
Gross margin	37%	39%	38%	(200bps)	(100bps)
Operating margin	6%	13%	8%	(700bps)	(200bps)
Operating profit (loss)	$2.498M	$5.497M	$2.507M	(54.56%)	(0.36%)
Net income (loss)	$2.414M	$5.075M	$2.569M	(52.43%)	(6.03%)
EPS	$0.06	$0.13	$0.08	(53.85%)	(25.00%)
(Non-GAAP)
Revenue	$42.236M	$43.954M	$33.426M	(3.91%)	26.36%
Gross margin	38%	39%	38%	(100bps)	–
Operating margin	13%	16%	10%	(300bps)	300bps
Operating profit (loss)	$5.320M	$6.819M	$3.450M	(21.98%)	54.20%
Net income (loss)	$5.309M	$6.804M	$3.401M	(21.97%)	56.10%
EPS	$0.14	$0.17	$0.11	(17.65%)	27.27%

Source: EMKR Form 8-K

Why EMKR may be a bargain at this point

EMKR has a problem with too much inventory out there, which could take several quarters to clear out. Sales and thus earnings are expected to drop along with demand. A direct consequence is that earnings expectations have also gone down. A number of industry analysts have revised their quarterly estimates downwards. Consensus estimates is that EMKR will basically break even for the rest of FY2022.

Revenue is estimated to end up at $141.3-144.3M in FY2022 with GAAP EPS coming in at $0.06-0.13. In comparison, revenue is $167.3M and EPS is $0.68 on a TTM basis, which shows the magnitude of the hit EMKR is about to suffer in upcoming quarters. The drop in earnings is why EMKR has a P/E of 5.4 on a trailing basis, which then drops to 38.7 on a forward basis. The table below shows the multiples EMKR trades at.

	EMKR
Market cap	$137.18M
Enterprise value	$82.85M
Revenue (“ttm”)	$167.3M
EBITDA	$25.1M
Trailing P/E	5.44
Forward P/E	38.74
PEG ratio	–
P/S	0.79
P/B	0.97
EV/sales	0.50
Trailing EV/EBITDA	3.30
Forward EV/EBITDA	6.25

Source: Seeking Alpha

On the other hand, there’s the possibility that analyst estimates may be too negative on EMKR. Remember that the forward multiples are based on estimates, whereas the trailing ones are based on actual numbers derived from quarterly reports. It’s possible that EMKR may wind up with quarterly numbers that are much better than what analysts are currently predicting. If this happens, EMKR could be a bargain with multiples where they are.

One could even make an argument that EMKR is priced too low. For instance, the stock has the distinction of trading below book value with a price-to-book of 0.97. There are those who believe that when stock value is below book value as is the case with EMKR, the stock is undervalued.

All of EMKR is assigned an enterprise value of slightly less than $83M after adjusting for net cash of around $55M on the balance sheet. An enterprise value of $83M for EMKR is not a whole lot. The earnings picture also looks better if one does not stick exclusively with GAAP. In terms of EBITDA, which strips out some of the restructuring charges mentioned earlier that affect earnings on a GAAP basis and the P/E multiple by extension, EMKR trades at 3.3 times EBITDA on a trailing basis and 6.25 times EBITDA on a forward basis.

Investor takeaways

EMKR is at a low point. The company is facing several headwinds. Higher costs and supply chain disruptions are giving EMKR problems, which found their way into the quarterly numbers. Nevertheless, they were overshadowed by the revelation of inventory building, which looks to have several repercussions.

Demand is expected to remain sluggish for some time, which is reflected in guidance calling for a sequential decline of almost 22% in Q2. The analyst community reacted with large downward revisions in earnings expectations. For instance, EMKR is now predicted to earn $0.06-0.13 per share in FY2022 using GAAP on revenue of $141.3-144.3M. In comparison, EMKR earned $0.72 in FY2021 on revenue of $158.4M.

In addition, the inventory building puts recent quarterly results in a different light. Recent quarters benefited from strong results in the CATV segment, but it now appears real demand was not as strong as the numbers suggest it was. There’s also some uncertainty as to how long it will take to clear out excess inventory. Management suggested it could take until the end of 2022, but that is not definitive.

If the large downward revisions in estimates from analysts are any indication, then the inventory issue is expected to linger around for even longer than that. Estimates only see a modest improvement in FY2023 with consensus estimates putting EPS at just $0.20. These numbers suggest that EMKR will perform more in line with years past when the company struggled with earnings growth and less like in FY2021.

The latter is considered an outlier due to the perceived impact of inventory building on the FY2021 numbers. EMKR finished with GAAP losses in prior years and the market seems to be open to the possibility of that happening once again. With all this in mind, there’s every reason for the bulls to throw in the towel.

However, while there are legitimate reasons to be wary of EMKR, sentiment may be overly negative towards EMKR. The consensus estimates suggest the downturn will last much longer than EMKR suggests it will. Granted, the inventory issue needs time to fix, but it’s not something that cannot be solved. It’s not a problem that is permanent in nature.

If the inventory issue clears up sooner than expected, current valuations for EMKR are way too low. EMKR still has a number of new products scheduled to be released in the second half of the year, which could spring a surprise. It’s not impossible for EMKR to beat expectations, especially when they are as low as they are right now.

Some may want to keep their distance from EMKR with everything going on, but I am bullish EMKR nonetheless. EMKR deserved to be taken down a notch due to the impending inventory correction, but an enterprise value of $83M looks too low for a company like EMKR. Heck, some companies might decide to put in an offer for EMKR at such a low valuation.

The stock value is below book value, which suggests EMKR is undervalued. For that to be justified, EMKR would have to undergo severe stress, far more than is the case right now. Things can always change, but that is not what is happening right now. The balance sheet is in good shape with cash accounting for more than one-third of EMKR’s market cap. It will take time and longs need to be patient, but EMKR should be able to overcome the inventory issue.

Bottom line, EMKR is admittedly not without risks. There’s the possibility that EMKR will be confronted with additional problems, which could delay the road to recovery. Still, as the saying goes, it’s darkest before dawn. EMKR may have been punished too much for it to be valued at $83M. The company is not that bad off. The recent price action with the stock outperforming suggests some people are beginning to realize that. Odds are more will come to that conclusion.