Nova: Bottom Is Not Likely To Be In Despite The Relief Rally

The Q3 report from Nova (NASDAQ:NVMI) came at just the right moment. The stock was having trouble holding on, but the latest earnings report triggered a strong rally in the stock with NVMI beating consensus estimates and guidance better than expected. However, there may still be reasons why some may decide to sit the rally out. Why will be covered next.

How the Q3 report from NVMI got the stock rolling

NVMI came into the release of the Q3 report with a number of issues weighing on the stock. While concerns abound in several areas, the Q3 report seems to have been successful in soothing most if not all of them, at least for the time being. For instance, the semiconductor market has shown increasing signs of weakness, which does not bode well for semiconductor equipment suppliers like NVMI.

However, the latest report suggests demand is holding strong, at least for now. Q3 results actually beat consensus estimates for the top and the bottom line. Q3 revenue increased by 27.7% YoY to a record $143.9M. GAAP EPS increased by 7.8% YoY to $1.10 and non-GAAP EPS increased by 6.9% YoY to $1.24. In comparison, consensus estimates were looking for revenue of $141.5M and non-GAAP EPS of $1.17. The table below shows the numbers for Q3 FY2022.

(GAAP)	Q3 FY2022	Q2 FY2022	Q3 FY2021	QoQ	YoY
Revenue	$143.906M	$141.628M	$112.713M	1.61%	27.67%
Gross margin	57%	57%	58%	–	(100bps)
Operating margin	27%	26%	32%	100bps	(500bps)
Operating income	$38.938M	$36.963M	$35.526M	5.34%	9.60%
Net income	$35.075M	$34.878M	$30.335M	0.56%	15.63%
EPS	$1.10	$1.09	$1.02	0.92%	7.84%
(Non-GAAP)
Revenue	$143.906M	$141.628M	$112.713M	1.61%	27.67%
Gross margin	58%	58%	58%	–	–
Operating margin	31%	32%	34%	(100bps)	(300bps)
Operating income	$44.716M	$45.306M	$38.742M	(1.30%)	15.42%
Net income	$39.698M	$39.546M	$34.546M	0.38%	14.91%
EPS	$1.24	$1.24	$1.16	–	6.90%

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Source: NVMI

The outlook also did much to put people at ease with guidance calling for Q4 FY2022 revenue of $142-152M, an increase of 21% YoY at the midpoint. The forecast expects GAAP EPS of $0.99-1.16, an increase of 47.3% YoY at the midpoint, and non-GAAP EPS of $1.15-1.32, an increase of 14.4% YoY at the midpoint. In comparison, consensus estimates called for revenue of $140M and non-GAAP EPS of $1.13.

	Q4 FY2022 (guidance)	Q4 FY2021	YoY
Revenue	$142-152M	$121.5M	16.87-25.10%
GAAP EPS	$0.99-1.16	$0.73	35.62-58.90%
Non-GAAP EPS	$1.15-1.32	$1.08	6.48-22.22%

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In addition, NVMI is projected to grow by at least 35% YoY in FY2022, which is faster than the single digits expected of the wafer fab equipment market. FY2022 revenue is expected to end up at $560M or more, which represents a CAGR of 20% in the last five years. From the Q3 earnings call:

“Moreover, including our fourth quarter guidance, the company is expected to present the following annual results on a non-GAAP basis. Annual revenues of more than $560 million, reflecting CAGR of 20% across the last five years and reflecting yearly revenue growth of 35% or more in 2022 relative to an expectation of single-digit wafer fab equipment growth in 2022. Gross margins of approximately 58% and operating margins of approximately 31% on an annual basis.”

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

There may be trouble lurking out there

However, it’s worth mentioning that not everything is picture perfect for NVMI. The U.S. government passed new export rules on October 7, which basically seek to restrict the sale of equipment needed to manufacture advanced semiconductor chips in China, a country that accounted for 21% of NVMI’s sales in FY2021.

The rules triggered a selloff in the industry, NVMI included. The stock lost close to 20% from October 7 to October 14, which suggests there is a lot of trepidation out there as to what impact the rules could have on NVMI. NVMI thus felt the need to address and add some clarification on the issue. The initial assessment from NVMI sees a reduction of about $10M in sales due to the new U.S. export rules.

“In October, the U.S. government issued new regulations to restrict some aspects of the U.S. semiconductor trade with China.

The regulations are mainly related to export control for advanced nodes in both Memory and Logic. As we continue to evaluate the impact of such restrictions on our U.S.-based activity and global export conditions, our initial assessment is that the direct impact on Nova’s overall business plan for 2023 is marginal and estimated at around USD 10 million in direct revenue, mainly from our U.S.-based operations.”

Management also added that most of its sales to China are not affected by the new rules. The impact on NVMI is expected to be limited.

“I just want to say that most of the revenues of the company in China are coming from trailing nodes that are not part of the restriction on advanced chip manufacturing. So overall, we think that the overall impact on the company will be anyway marginal.”

Still, while the export rules may be manageable, NVMI does see other potential hurdles out there. The recent softening in demand for semiconductor chips has not gone unnoticed.

“The impact on semiconductor pricing, particularly in Memory, along with other economic and geopolitical factors is driving our customers to be more conservative in the near term.”

More and more chipmakers are seeing weakening demand for semiconductor chips, which is putting pressure on prices. As a consequence, chip makers have become more cautious when it comes to investing in new production capacity, which could become a headwind for suppliers of related equipment like NVMI.

Valuations may not be enticing to everyone

Guidance does not show it, but it is possible demand for semiconductor manufacturing equipment may start to falter in the coming quarters, especially if the semiconductor market continues to weaken. This is the risk longs are taking with a stock like NVMI. Some may be okay with it, but others may balk, especially if they feel NVMI is too expensive considering the risk of a slowdown with an industry downturn.

The table below shows some of the multiples NVMI trades at. NVMI trades at 19 times forward earnings with a trailing P/E of 21. This is roughly in line with the median in the sector at roughly 22x. Overall, NVMI is not an expensive stock, but it does not trade at levels that would necessarily entice people to set aside the risks that come with NVMI.

	NVMI
Market cap	$2.32B
Enterprise value	$2.07B
Revenue (“ttm”)	$541.0M
EBITDA	$157.4M
Trailing GAAP P/E	20.92
Forward GAAP P/E	19.19
PEG ratio	0.53
P/S	4.44
P/B	4.35
EV/sales	3.83
Trailing EV/EBITDA	13.16
Forward EV/EBITDA	10.70

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Source: Seeking Alpha

The stock is rallying

NVMI is dealing with export restrictions and a possible industry slowdown, but the stock has nonetheless given the latest report a thumbs up. The stock has gained almost 16% since November 3 when the Q3 report was released. The chart below shows how the stock has almost erased all the losses suffered in the wake of the U.S. export rules. Still, the stock is down 42% YTD.

The recent rally notwithstanding, it’s worth noting that the chart patterns are still leaning towards the downside. Note how resistance seems to be in the $107.50-112.50 region, which is where the stock has topped out several times in recent months. In contrast, support is giving ground with the stock setting lower lows, which can be connected to form a lower trendline that is descending, unlike resistance which is standing strong and therefore flat.

It’s also worth mentioning that the stock came close to overtaking the 50-day moving average, which would have been a bullish signal, but the stock was unable to do so after being rejected. Overall, with lower lows and no higher highs, the charts suggest the stock is more likely to be heading lower than higher in the near term.

Investor takeaways

At the very least, the latest report from NVMI provided some short-term relief. Earnings were better than expected and so was guidance. The recent U.S. export rules caused the stock to drop, but management suggests the impact will not be as bad as the market had perhaps feared. The market responded with a strong rally, allowing the stock to recoup most of the losses suffered in the wake of the new export rules.

However, concerns may have eased, but they remain out there. The U.S. government has not targeted trailing-edge equipment, which is what NVMI supplies to China for the most part, but that could change. The same can be said of the market for semiconductor manufacturing equipment. Q3 earnings and Q4 guidance suggest the market is holding strong for NVMI, but that could change, perhaps as soon as next year.

Companies are still spending on new equipment, as shown by the latest earnings and guidance, but the more the market for semiconductor chips slows down, the less likely it becomes spending will not go down. With more and more companies reporting weakening demand for semiconductor chips, it is only a matter of time before demand for equipment from the likes of NVMI weakens as well.

I am neutral on NVMI as mentioned in a previous article. The stock is currently in the midst of a powerful relief rally after earnings, guidance and earnings call comments, specifically regarding recent export rules, suggested the situation is not as bad as initially thought. However, the stock has gone through these rallies before and what has followed has been the same. No higher highs, but lower lows instead.

Resistance has been able to stand its ground, but the same is not true of support. Support is ceding ground, opening the door to lower lows. The charts suggest the current rally will most likely end the same way the others did this year. Run out of steam and reverse course on the way to new lows.

The industry outlook suggests NVMI is heading lower. It’s true there are no signs yet of weakening demand for semiconductor equipment based on recent earnings and guidance, but that’s almost certain to come if things stay the way they are. Namely, a continued weakening in demand for semiconductor chips. It’s hard to imagine chip makers will keep investing in new equipment if chip demand isn’t there.

Bottom line, the stock may continue to rally for a while longer, but the stock is more likely to see new lows than new highs. While multiples are not unreasonably high, they are not low enough to make NVMI a screaming buy, especially with the risk of a looming industry slowdown and the effect that will have on growth and earnings. The future is not set in stone, but if one were to guess the direction of NVMI in the near term, it’s most likely down.