EMCORE Corporation: It Is Darkest Before Dawn (NASDAQ:EMKR)

EMCORE Corporation (NASDAQ:EMKR) is in a hole. The inventory issue revealed earlier in the year has started to negatively impact earnings in a big way, putting EMKR firmly in the red. The stock itself has lost over half of its value YTD. However, the stock is no longer in decline. The worst may have passed for EMKR. Why will be covered next.

Who is EMKR

EMKR may not be a household name, but as a supplier of optical semiconductors and mixed-signal devices that incorporate analog and digital circuits, its components are used by many well-known companies in a wide range of industries. EMKR’s product line can be split into two segments, the broadband segment and the aerospace & defense or A&D segment.

In the broadband segment, EMKR supplies, for instance, optical transmitters and other components to companies like Comcast (CMCSA) and Cisco (CSCO) to build high-speed communication networks. Other products include semiconductor chips for hyper-scale datacenters build by companies like Amazon (AMZN) and Google (GOOG, GOOGL).

In the A&D segment, EMKR is a provider of inertial navigation systems, inertial measurement units and other sensors for stabilization that are utilized in a range of products, including intercontinental and other long-range ballistic missiles, precision guided munitions and unmanned aerial vehicles or UAVs produced by companies like Raytheon (RTX) and Lockheed Martin (LMT).

Why the worst may have passed for EMKR

The stock has lost 55% of its value YTD. That is bad, but most of the losses came in the first two months of the year as shown in the chart below. The stock was already heading down prior to this, but things got a lot worse in February when the stock fell off a cliff after EMKR identified an inventory problem at one of its customers. This excess inventory is expected to have a negative impact on the quarterly numbers for some time. A previous article goes deeper into this issue.

However, the decline has come to a virtual standstill, with the stock staying above the $3 price level for the last several months. Note how in the chart above there is a declining trendline that goes all the way back to last year. EMKR is on the verge of breaking through this trendline by virtue of going sideways. All the stock has to do is to keep doing what it has been doing for the last several months and the trend will be broken. In addition, going sideways brings it closer and closer to overtaking the 50-day moving average, a bullish signal.

The stock may be in the process of building a base by going sideways. This would be reminiscent of what happened back in mid-2020, when the stock spent months hovering over the $3 price level, before the stock started to ascend in late 2020 until it peaked in mid-2021. If history repeats itself, the stock may go on another rally once it is done building a base on top of the $3 region.

It’s possible the stock could still break below the $3 region, but history suggests it won’t. Going back further in time shows the stock bottoming in the $3 region on numerous occasions. It happened, for instance, in 2019 after a multi-year decline starting in mid-2017. There are numerous other instances in the 2012-2014 time frame of the stock reversing course after hitting bottom at $3 or so. If history is any indication, the stock may have once again hit bottom now that it has reached the $3 region. The odds definitely favor this outcome.

On the other hand, if support fails and the stock falls below the $3 region, then there may be a long way to go before the stock recovers. The one notable exception when the stock did fall below the $3 region occurred in March 2020 after the stock collapsed due to COVID-19. When that happened, EMKR fell all the way to $1.46, which happens to be the low in the last ten years. In other words, the stock could potentially lose another 50% or so if support in the $3 region does not hold.

Why long EMKR is worth considering

Odds are EMKR has hit bottom in the $3 region, but chart patterns are not the only argument in favor of the bull case. Another one is valuations, although it’s not as clear-cut as it used to be. For instance, while EMKR has a market cap of $117M, its enterprise value stands at just $56M thanks to having $80.9M in cash on its balance sheet. It’s true EMKR is currently experiencing problems, mostly due to inventory building, but some would argue that $56M is too low a value for a company like EMKR.

EMKR has a tangible book value of $139.4M, or approximately $3.72 per share. EMKR has a price-to-book of 0.83, significantly below the 1.0 threshold people keep an eye on. Quite a number of people believe a company is undervalued when its stock trades below its book value, as is the case right now with EMKR. The table below shows the multiples for EMKR.

On the other hand, a stock can be valued at less than its book value when there is the perception that the company is heading for financial difficulties. For example, if the company is expected to suffer sustained losses that could eat away at the balance sheet. This could happen even if the balance sheet is in good shape at the moment.

Now also how forward multiples are expected to deteriorate compared to the trailing ones. EMKR, for instance, does not have a forward P/E with EMKR expected to finish in the red in FY2022. EMKR trades at 3 times EBITDA on a trailing basis, but this jumps to 24 times EBITDA on a forward basis, which reflects a drastic deterioration in future earnings.

	EMKR
Market cap	$116.69M
Enterprise value	$56.18M
Revenue (“ttm”)	$161.5M
EBITDA	$17.3M
Trailing P/E	6.23
Forward P/E	N/A
PEG ratio	0.04
P/S	0.71
P/B	0.83
EV/sales	0.35
Trailing EV/EBITDA	3.24
Forward EV/EBITDA	24.46

Source: Seeking Alpha

Why earnings are expected to get worse in the near term for EMKR

As mentioned earlier, EMKR discovered a problem with inventories at a major customer. As a result, sales and earnings are expected to decline due to the need to clear excess inventories. The most recent earnings report shows the impact on EMKR. Q2 revenue declined by 22.7% QoQ and 15% YoY to $32.7M. Gross and operating margins dropped.

EMKR flipped into the red after suffering a net loss of $2.2M or $0.06 per share in terms of GAAP and a net loss of $750,000 or $0.02 in terms of non-GAAP. Adjusted EBITDA barely managed to stay out of the red at plus $270,000. There was also share dilution with the weighted-average number of shares at 37.2M in Q2, up from 34.5M a year ago. The quarterly numbers have certainly gotten a lot worse. The table below shows the numbers for Q2 FY2022.

(GAAP)	Q2 FY2022	Q1 FY2022	Q2 FY2021	QoQ	YoY
Revenue	$32.650M	$42.236M	$38.406M	(22.70%)	(14.99%)
Gross margin	28%	37%	38%	(900bps)	(1000bps)
Operating margin	(7%)	6%	12%	(1300bps)	(1900bps)
Operating profit (loss)	($2.313M)	$2.498M	$4.583M	–	–
Net income (loss)	($2.225M)	$2.414M	$4.384M	–	–
EPS	($0.06)	$0.06	$0.13	–	–
(Non-GAAP)
Revenue	$32.650M	$42.236M	$38.406M	(22.70%)	(14.99%)
Gross margin	30%	38%	39%	(800bps)	(900bps)
Operating margin	(2%)	13%	15%	(1500bps)	(1700bps)
Operating profit (loss)	($0.738M)	$5.320M	$5.923M	–	–
Net income (loss)	($0.750M)	$5.309M	$5.874M	–	–
EPS	($0.02)	$0.14	$0.17	–	–

Source: EMKR Form 8-K

Guidance calls for Q3 FY2022 revenue of $25-27M, a decline of 20.4% QoQ and 39.1% YoY at the midpoint. Furthermore, guidance would have been even worse if not for the expected contributions of roughly $3.5M from recent acquisitions. EMKR is projected to post a GAAP loss of $0.24 per share in FY2022, mostly due to a GAAP loss of $0.15 per share in Q3. On the other hand, Q4 is expected to show improvement with a GAAP loss of $0.09 per share.

Too much transmitter inventory may be the biggest issue facing EMKR at the moment, but it’s not the only one. EMKR is facing headwinds on the supply side as well. From the Q2 earnings call:

“Semiconductor availability was a difficult problem in the quarter and costs were up across the board. Microcontrollers and FPGAs were particularly problematic experiencing substantial price increases, other unpredictable logistics challenges that we saw in Q1 remained with us in Q2, causing some surprise pushouts of material that we expected. Those problems are likely to persist going forward, and we don’t see a catalyst to drive predictability into the supply chain in the short term. Some components have lead times stretched to over 90 weeks.”

A transcript of the Q2 FY2022 earnings call can be found here.

Investor takeaways

If there were still people out there who harbored any hopes that the inventory issue might not be so bad after all, then the Q2 results should put those doubts to rest. EMKR officially became a company in the red in Q2. Furthermore, sales and earnings are expected to decline even more in Q3. There should be no doubt that EMKR is facing a tough environment due to excess inventory and supply chain problems to a lesser extent.

EMKR is in a hole, but there are signs EMKR is starting to climb its way out of it. The good thing about excess inventory is that it is a problem that will take care of itself, provided it is given enough time. EMKR just needs to be patient while existing inventories are drawn down. Moreover, EMKR has new products scheduled to be released in Q4, which should give sales a lift. It may even be enough to end FY2022 on an encouraging note, even if sales and earnings are yet to fully recover.

There are no guarantees, especially with EMKR having to contend with problems on the supply side, but Q3 could very well be the trough as far as earnings are concerned. EMKR will need time to fully recover, but there’s a realistic chance the numbers will get better once we are past Q3. The price action in recent months suggests the market is leaning towards this view.

The stock is no longer declining the way it used to earlier in the year. The stock has been hovering just above $3 or so, despite lots of opportunity for the stock to fall below this price region with all the turmoil in the stock market. The $3 region has proven over the years to be a strong support level and odds are support will hold its ground once more.

Longs will likely have to wait for any rewards with EMKR needing time to fix its problems, but I am bullish EMKR. There is reason to believe the stock has hit bottom. It probably won’t happen right away, but the stock is most likely heading up. Multiples will get worse in the short term as sales and earnings decline, but less than $60M for a company like EMKR looks too good to pass on. There’s even an outside chance EMKR may receive a buyout offer at such a low valuation.

EMKR can still count on being a supplier of inertial navigation systems to the defense industry, which by its nature is not open to everyone. EMKR is still one of only two QMEMS gyro suppliers in the world. EMKR cannot be missed. Semiconductor manufacturing utilizing indium phosphide could become a growth driver for EMKR with good prospects in the datacenter market due to the need for high-speed applications.

It’s true EMKR has problems that need fixing, but EMKR is highly unlikely to be held down by these problems in the long run. EMKR is unlikely to go out of business, yet it is increasingly being valued as one that is getting ready to. The stock value is way below its book value. Granted, EMKR is suffering losses at the moment, but there’s a path forward to getting out of it and EMKR has more than enough cash on hand to deal with any losses. Nothing is set in stone, but the worst may have already passed. It’s usually darkest before dawn. Long EMKR is worth it.