PonyWang
The market participants know that the vast majority, if not all, of the unprofitable growth stocks with sky high metrics and rosy growth prospects that burn cash have collapsed since 2021. This crash was a reality check. But it’s obvious that some of these market participants have not learned the lesson yet despite their huge losses, so they keep buying growth and rosy plans at any price ignoring key fundamental details.
As such, I decided to write an article about Wolfspeed Inc. (NYSE:WOLF). I strongly believe that WOLF is an excellent short candidate at the current price levels due to a handful of reasons that have created a very ugly mix.
The Fundamentals Remain Very Weak
WOLF’s Q4 FY 2022 results were out a few days ago. And its fundamentals remained very weak, because its losses and cash burn continue unabated, among other key negatives. Specifically:
1) Losses continued for another quarter in a row being almost ($62) million in Q4, so losses largely remained flat sequentially despite the sequential revenue growth.
2) Gross profit margin largely remained flat sequentially. Specifically, GAAP gross margin in Q4 FY 2022 was 34.5% compared to 34% in Q3 FY 2022. And gross profit margin largely remained flat in FY 2022 compared to FY 2021. Specifically, as linked above, GAAP gross margin in FY 2022 was 33.4% compared to 31.3% in FY 2021.
3) Adj. EBITDA was negative for another quarter in a row being approximately ($3.5) million in Q4 and approximately ($7) million in FY 2022. On that front, I would like to point out that I calculated adj. EBITDA by adding these items to the operating loss: “Depreciation and amortization”, “Amortization of debt issuance costs and discount, net of non-cash capitalized interest”, “Loss on extinguishment of debt”, “Stock-based compensation” and “Amortization of premium/discount on investments”.
4) Cash burn continued for another quarter in a row, so cash & cash equivalents & short-term investments dropped approximately $88 million sequentially. Specifically, they were almost $1.29 billion in Q3 and dropped to $1.2 billion in Q4.
5) Negative operating cash flow continued for another quarter in a row being ($31) million in Q4, so it went up sequentially compared to negative operating cash flow of approximately ($28) million in Q3, despite the sequential revenue growth.
Based also on the outlook for Q1 FY 2023, losses will continue in the first quarter of the new fiscal year. And I project that in Q1 FY 2023, the company will report negative operating cash flow and another cash burn.
Fierce Competition That Becomes Fiercer
It must be pointed out that WOLF is not alone in the silicon carbide (“SiC”) chips manufacturing. The competition is fierce and will become fiercer in the next quarters. I emphasize this because I strongly believe that many investors have overplayed WOLF’s presence in the silicon carbide power semiconductors market while missing the investments from many established companies in this segment of the semiconductor industry. On top of this, the investments from new and existing peers will increase significantly in the next quarters making the competition even stronger.
Specifically, the major players in the Silicon Carbide Power semiconductors market currently are many, both privately-held and publicly-traded such as Infineon Technologies AG (OTCQX:IFNNY), Microsemi that was acquired by Microchip Technology (MCHP), Fairchild Semiconductor that was acquired by ON Semiconductor (ON), Bosch GmbH, Power Integrations (POWI), Toshiba Corporation (OTCPK:TOSYY), STMicroelectronics (STM), NXP Semiconductors (NXPI), Tokyo Electron Limited (OTCPK:TOELY), Renesas Electronics Corporation (OTCPK:RNECY), ROHM Co. (OTCPK:ROHCY), ESK-SiC GmbH, ESD-SIC BV, Grindwell Norton Ltd., Entegris Inc. (ENTG), Saint Gobain Ceramic Materials GmbH, AGSCO Corporation, Carborundum Universal Limited, Mitsubishi Electric Corp. (OTCPK:MIELY), Fuji Electric Co. (OTCPK:FELTY), as shown here, here and here.
And I emphasize that the list is growing, because this is a highly dynamic industry. This is a rapidly changing landscape and the competition will become even more intense in the next quarters with Japan aiming to lead the world in SiC.
Specifically, Japan’s Renesas recently announced that it will invest $700 million into doubling power chip production. Toshiba recently announced that it will spend $840 million to increase its production on power semiconductors to more than three times the capacity of fiscal 2020 in fiscal 2023, and to 10 times as soon as possible. Mitsubishi Electric will invest about 130 billion yen by the end of fiscal 2025 to increase production capacity by about one time compared to fiscal 2020. Fuji Electric has begun mass production of high-performance next-generation SiC chips and will increase its production capacity for SiC chips by around 10 times by 2024. Rohm is investing approximately 50 billion yen to expand its production capacity of silicon carbide power semiconductors by more than five times by 2025. Rohm has already built a new plant and started mass production in the new plant this year.
Furthermore, rising competition is coming from the U.S. and European names too. For instance, one of them is Qorvo (QRVO) given that QRVO acquired United Silicon Carbide last November. Last February, IFNNY announced that it doubles down and invests more than €2 billion in a new Kulim, Malaysia frontend fab to expand its market leadership in power semiconductors. Germany’s Bosch announced last year that it expands its SiC chips production in 2022 while also saying that it wants to become a global leader in the production of SiC chips for electromobility. STM started on its European SiC wafer megafactory last February. And ON recently celebrated the expansion of its plant that will increase its SiC production capacity by five times year-over-year and almost quadruple the number of its employees in Hudson by the end of 2022.
Sky High Valuation On Absolute And Relative Basis
When it comes to investing, valuation does matter. If you don’t believe me, check the numerous unprofitable growth stocks with sky high metrics that burn cash have collapsed over the last 12 months. The massive wealth destruction is (or should be) a valuable lesson for many growth investors who have incurred tremendous losses since 2021, when they overpaid for these companies and bought growth at any price.
This time is no different. First, WOLF’s growth of 42% in FY 2022 is not jaw-dropping. I believe that this is not such a strong YoY growth that should make investors gloss over WOLF’s losses and cash burn. However, this 42% YoY growth would be fine, if this unprofitable cash incinerator had a low valuation. But this is not the case. And WOLF’s “pipeline” can’t justify the insanely high valuation either.
Specifically, WOLF announced losses and negative adj. EBITDA in FY 2022, so its P/E and Enterprise Value-to-adj. EBITDA ratios are undefined. Based also on the company’s guidance for Q1 FY 2023, WOLF will remain an unprofitable company in the near future. Therefore, the remaining key valuation metric is its Enterprise Value-to-Revenue ratio.
That said, WOLF’s Enterprise Value at $109 per share is about 18.2 times its FY 2022 revenue. I believe that this is a sky high ratio based on absolute valuation.
Based on the guidance, WOLF expects to generate more than $1 billion in revenue in FY 2023, so WOLF’s Enterprise Value at $109 per share is about 13.5 times its FY 2023 revenue. This is again a sky high ratio based on absolute valuation.
And what about the relative valuation? Do all the companies from the silicon carbide power semiconductors market trade more than 10 times their revenue? The answer is a big fat “NO” and the numbers speak volumes:
|
Company |
EV-to-Revenue (*) |
|
WOLF at $109 per share |
18.2 |
|
MHCP |
5.8 |
|
POWI |
5.8 |
|
ENTG |
5.4 |
|
ON |
4.1 |
|
NXPI |
4 |
|
QRVO |
3.1 |
|
IFNNY |
2.7 |
|
ACLS |
2.5 |
|
STM |
2.1 |
|
AOSL |
1.2 |
(*) Based on the closing prices of 08/19/2022
As illustrated above, the valuation gap between WOLF and its peers is tremendous. But some key fundamentals do matter.
Specifically, all the aforementioned peers do grow their top lines on a YoY basis, according to their latest reports. It’s not that the aforementioned peers do not increase their revenue and WOLF is the only name from the silicon carbide power semiconductors market that announces revenue YoY growth.
Additionally, all the aforementioned peers don’t only grow their top lines on a YoY basis but also they are profitable with positive operating cash flow and positive free cash flow.
For comparison, WOLF is an unprofitable cash incinerator and its losses will continue in Q1 FY 2023, based on the company’s guidance linked above.
Therefore, “tremendous” may not the right word to fully describe this valuation gap. Perhaps, something bigger than tremendous is needed to fully describe the situation. Help wanted.
Last but not least, the average ratio for the aforementioned profitable peers that grow their top lines and generate cash is about 4 times their revenue. If we apply the average ratio to WOLF’s valuation, WOLF’s Enterprise Value should currently be about $4 billion, based on its FY 2023 revenue. Therefore, if WOLF was profitable and generated cash, I estimate that its fair valuation would be about $32 per share, based on its FY 2023 revenue.
Given that WOLF is an unprofitable cash incinerator with no end in sight in my opinion, I believe that WOLF should currently trade below $32 per share, based on its FY 2023 revenue.
Debt, Dilution Or Both Are On The Horizon
On top of the aforementioned key negatives, there is one more that must be added to the mix. WOLF has already $1 billion in interest-bearing debt and its negative net debt dropped to $180 million after the cash burn of $88 million in Q4 FY 2022. And we project that WOLF will continue to burn cash in FY 2023.
On that front, WOLF announced capacity expansion this fiscal year, as quoted below:
Reynolds estimated the capacity expansion will cost $550 million in Wolfspeed’s fiscal year 2023, and said the company is exploring ways to finance the coming capital expenses – including through possible government subsidies.”
And the high CapEx for this fiscal year don’t end here. CapEx in FY 2023 will go even higher than $550 million, approaching or exceeding the company’s annual revenue, because WOLF plans to expand its materials and device capacity too, as quoted below:
In addition, we are also planning further expansion of our Materials and device capacity, and we are evaluating multiple avenues to finance these capital investments, including through upfront customer payments, capital markets, debt, government project funding, subsidies and others, all while keeping a keen eye on our cost of capital and dilution for our current stockholders. The $550 million of net CapEx in 2023 is not inclusive of these additional items, and we will give further updates on both our CapEx investment and financing plans when we have more visibility to the nature and timing of these expansions. “
This means that a significant amount of new debt or dilution or both are on the horizon. And this new debt will come amid rising interest rates. As a result, the new debt will likely weaken the capital structure with the company’s leverage going up, while the interest will impact negatively the company’s bottom line in the foreseeable future.
When it comes to the dilution, I believe that WOLF will announce a placement soon, because the company needs to fund the aforementioned projects this fiscal year that started on June 27, 2022.
Risks
Are there any factors that can challenge this bearish thesis and can drive the stock price upwards? I would say that a couple of factors could push WOLF higher than the current price levels.
First, it could be a market-related factor. For instance, the stock market could climb higher, so the positive momentum and market sentiment could help WOLF’s stock exceed $109. However, I believe that the move higher than $109 will not last due to the negatives mentioned in the previous paragraphs. In other words, I believe that the rally will be short-lived, because the fundamentals will prevail sooner or later.
Second, it could be a company-specific factor. For instance, WOLF could revise its guidance for FY 2023 stating that it will finally become a profitable company that will generate positive operating cash flow and free cash flow this fiscal year. In other words, I project that such a big positive change on the fundamentals could push WOLF higher than the current price levels.
Takeaway
The market participants have seen this movie many times before. But it seems that some of them have not learned the lesson yet, despite the fact that they have lost billions of dollars, as numerous unprofitable growth stocks with sky high key metrics and rosy growth prospects that burn cash have collapsed since 2021. This crash was a stark reminder about the fact that valuation does matter and fundamentals prevail sooner or later.
WOLF is no different. WOLF is another unprofitable growth stock that in my opinion, has a shockingly high valuation on absolute and relative basis, while facing fierce competition that will become fiercer in the next quarters.
As such, I forecast that its stock will collapse sooner or later. Due also to the reasons presented in the previous paragraphs, I estimate that WOLF’s fair price is below $32 per share, based on its FY 2023 revenue.
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