Ichor Holdings: Headwinds Have Not Gone Away Despite The Rally (NASDAQ:ICHR)

Ichor Holdings, Ltd. (NASDAQ:ICHR), a provider of fluid delivery subsystems to some of the leading makers of semiconductor manufacturing equipment such as Applied Materials (AMAT) and Lam Research (LRCX), posted strong results in its latest Q3 report. In fact, Q3 revenue and earnings set new records and were well ahead of expectations.

However, the market reaction to the latest report was tempered by an outlook that suggests the numbers are set to decline in the coming quarters. Still, the stock has rallied in recent days for a variety of reasons. Why will be covered next.

Q3 was a good one for ICHR

Consensus estimates expected revenue of $340M and non-GAAP EPS of $0.99 in Q3. Instead, Q3 revenue sailed past expectations with an increase of 35.3% YoY to $355.6M, a record high. GAAP EPS increased by 56.3% YoY to $1.00 and non-GAAP EPS increased by 50.6% YoY to $1.22, another record high. Gross margins improved more than expected. ICHR finished with total debt of $304M on its balance sheet at the end of Q3, partially offset by $56.5M in cash and cash equivalents. The table below shows the numbers for Q3 FY2022.

(GAAP)	Q3 FY2022	Q2 FY2022	Q3 FY2021	QoQ	YoY
Net sales	$355.643M	$329.560M	$262.855M	7.91%	35.30%
Gross margin	17.9%	16.8%	16.6%	110bps	130bps
Operating margin	9.2%	7.5%	8.1%	170bps	110bps
Operating income	$32.547M	$24.796M	$21.197M	31.26%	53.55%
Net income	$29.031M	$21.537M	$18.537M	34.80%	56.61%
EPS	$1.00	$0.74	$0.64	35.14%	56.25%
(Non-GAAP)
Net sales	$355.643M	$329.560M	$262.855M	7.91%	35.30%
Gross margin	18.0%	17.0%	16.7%	100bps	130bps
Operating margin	11.6%	10.0%	10.5%	160bps	110bps
Operating income	$41.271M	$32.981M	$27.705M	25.14%	48.97%
Net income	$35.354M	$28.326M	$23.421M	24.81%	38.14%
EPS	$1.22	$0.98	$0.81	24.49%	50.62%

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Source: ICHR

The outlook, however, was something else. Guidance calls for Q4 FY2022 revenue of $315-355M, an increase of 16.6% YoY, but also a decline of 5.8% QoQ at the midpoint. The forecast expects GAAP EPS of $0.57-0.83, an increase of 37.3% YoY at the midpoint, and non-GAAP EPS of $0.80-1.04, an increase of 2.2% YoY at the midpoint. Both also represent sequential declines.

FY2022 revenue is projected to grow to $1,293-1,333M with the latest guidance, an increase of about 20% YoY. ICHR will have also grown at a CAGR of 24% in the last seven years with the latest numbers. In comparison, the wafer fab equipment or WFE market has a CAGR of 16% during this period. ICHR has grown faster than most in the industry.

(GAAP)	Q4 FY2022 (guidance)	Q4 FY2021	YoY (midpoint)
Revenue	$315-355M	$287.2M	16.64%
GAAP EPS	$0.57-0.83	$0.51	37.25%
Non-GAAP EPS	$0.80-1.04	$0.90	2.22%

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Still, it’s worth noting that the top and the bottom line are predicted to decline sequentially in Q4. Keep in mind that management had in the past stated the company would grow sequentially throughout the year and into Q1 of next year, which means ICHR has lowered its outlook with the latest guidance calling for both revenue and earnings to shrink sequentially.

In addition, the outlook suggests the slump will last several quarters. It also leaves open the possibility of a further deterioration in the outlook. From the Q3 earnings call:

“At this time, with our current visibility, we are expecting mid to high single digit percentage declines in our revenues on a sequential basis, at least for the next couple of quarters. Again, this assumes that the majority of WFE declines will be in the memory segment, which we estimate to comprise just 35% to 40% of our sales in 2022.”

A transcript of the Q3 FY2022 earnings call can be found here.

There are several reasons why ICHR has decided to revise its outlook.

“Since our last earnings call, expectations for levels of wafer fab equipment investments in the coming year have declined significantly. The initial forecast reductions centered primarily around the increasing softness seen in the memory markets and increasingly conservative commentary around memory CapEx going into 2023.

And then in early October, use of export restrictions to certain domestic semiconductor manufacturers in China effectively reduced WFE forecasts by $8 billion to $10 billion for next year.

We have incorporated the impact of the export restrictions in our outlook and build plants. We estimate that the total impact of these changes to be approximately $20 million this quarter. And as such, the midpoint of our Q4 revenue guidance represents a 6% decline from our record third quarter”

Chip makers have become more cautious in terms of what they are willing to invest in new equipment due to increasing signs of weakening demand for semiconductors, memory chips in particular. The recent passing of new export rules by the U.S. government did not help either.

The stock gets help from another corner

If not for the outlook, the Q3 report would likely have gotten a better reception than it did. Alas, the stock rose on November 9, only to close the day flat in response to the latest report. The Q3 report did not have what it took to get the stock going. However, all was not lost as a couple of other events came to the rescue.

The first were the latest inflation numbers on November 10, which were better than expected. The market has strengthened in anticipation of a potential Fed pivot in terms of monetary policy and the drop in the inflation numbers only strengthened the case in favor of less tightening by the Fed. Rising interest rates have made tech stocks less attractive to investors and a change in interest rate policy by the Federal Reserve could reduce the pressure on semis, if not remove it altogether.

Secondly, the semiconductor sector got some welcome news from upbeat comments made by high-profile companies like Taiwan Semiconductor (TSM) and ASML Holding (ASML), which coincided with the most recent inflation numbers. The latter, especially, was relevant to ICHR as the dominant supplier of lithography systems, with ASML suggesting the U.S. export rules will not constrain growth in the industry, especially as it relates to EUV demand, which is what ICHR has been banking on for growth.

The semiconductor sector has been troubled by signs of weakening demand for semiconductor chips, but if TSM and ASML are right, the health of the semiconductor market may be better than the market assumed it to be. Put these two together and you can see why the stock has gone on to rally, as shown in the chart below.

The stock closed at $21.69 on October 20, but it has since gained 33% in value to close at $28.89. Furthermore, the chart patterns suggest the rally may not be done yet. For instance, the stock has overtaken the 50-day moving average, which suggests the bulls are currently in the driver seat. The stock also seems to have posted a double bottom, which is regarded as a bullish signal.

The stock hit an intraday low of $21.04 on October 13, which is within pennies of the intraday low of $21.08 set three months earlier on July 5. Keep in mind that the stock proceeded to gain 66% after the July low. The stock is still down 37% YTD, but the stock’s recent rally may have some legs to it if it repeats what it did previously after bouncing off the low.

ICHR is not expensive

It helps that valuations for ICHR are on the low side, which could provide the rally with the fuel to keep going. For instance, ICHR trades at 11 times forward earnings with a trailing P/E of 12. To put this in perspective, the median for the sector are 24x and 23x respectively. The table below shows some of the multiples ICHR trades at.

	ICHR
Market cap	$846.51M
Enterprise value	$1.13B
Revenue (“ttm”)	$1,172.7M
EBITDA	$117.6M
Trailing GAAP P/E	11.57
Forward GAAP P/E	10.81
PEG ratio	3.96
P/S	0.66
P/B	1.49
EV/sales	0.89
Trailing EV/EBITDA	8.54
Forward EV/EBITDA	7.49

Click to enlarge

Source: SeekingAlpha

Investor takeaways

ICHR posted its fifth consecutive sequential increase in revenue with both revenue and earnings reaching record highs in Q3, but the outlook believes Q3 will be as good as it gets for a while. The outlook sees the top and the bottom line shrinking in the next several of quarters for a number of reasons.

The U.S. government has imposed export controls on China, which puts restrictions on what kind of semiconductor manufacturing equipment can be sold to China by companies such as Applied Materials or Lam Research. This impacts ICHR as a supplier to the aforementioned companies. The export controls resulted in Q4 guidance being reduced by $20M.

A bigger headwind could be chip makers cutting back on capex spending. A growing numbers of companies have decided to cut back on new production capacity due to weakening demand for semiconductors. As a consequence, ICHR has lowered its outlook from where it was earlier in the year. ICHR expected to keep growing sequentially until at least the first quarter of next year, but it now sees the possibility of a sequential decline in revenue for the next several quarters. And that’s assuming the decline in demand is mostly confined to the memory market and does not deteriorate even further.

It may be tempting to be long ICHR with the way the stock has rallied recently, but I remain neutral on ICHR as stated in a previous article. The stock has been weighed down by a number of issues, but a number of positive developments as to Fed policy and the health of the semiconductor market have helped ease concerns, paving the way for the stock to go on a major rally.

Nevertheless, the jury is still out on whether the semiconductor industry is on as strong a footing as some have recently suggested. TSM, for instance, still cut capex spending like many others did in spite of good earnings. It may also have been premature to assume the Fed is about to embark on a policy change.

The market has assumed both issues are in the process of being resolved, but if that turns out to be a mistake, the stock could easily give up all recent gains and then some. Remember that while the stock did jump 66% off the July lows, it proceeded to give it all back once it became clear the semiconductor market was getting weaker and there was no relief in terms of monetary tightening.

Bottom line, while recent developments are welcome, it would be a mistake to assume the headwinds that have caused problems for ICHR have been resolved and are no more. The reality is that despite the recent optimism, ICHR’s own outlook sees the numbers getting worse in the near future and not better. While the stock could go higher, it is hard to see how the stock will be able to keep it up if the quarterly numbers get worse. The stock has been very volatile this year with rallies followed by selloffs and vice versa. The risk is that the current rally will end up just like that. Buyer beware.