Analyst UpdateCompelling Valuation & Industry Strength. Introducing as Top
Pick
Bottom line: We are anointing Photon Control (“Photon” or the “Company”) as one of
Echelon’s Top Picks. We believe Photon presents exceptional risk-reward characteristics at current levels. Namely, with end-markets in a full upswing and $0.32/shr in cash on the
balance sheet, we expect limited downside and an upward bias to our forecasts.
Furthermore, we see solid FCF generation driving the Company’s cash balance to $0.39/shr by year end. Our forecasted EBITDA growth of 24.2% in 2020 on 10.7% top line growth, help sustain the Company’s healthy ROIC. Catalysts include a substantial jump in quarterly revenues/earnings relative to soft comparable quarters last year, as well as the potential for M&A activity. Our DCF-derived $1.75/shr target price provides for 35% return from current levels. Further industry strength can shift our forecasts and target price materially higher.
Contextualizing Photon’s current valuation: As we pointed in October 2019, rapidly
improving industry fundamentals have yet to be reflected in Photon’s estimates and
valuation (see note here). Recent earnings announcements and conference call commentary by Lam Research (LRCX-NASDAQ, NR), Applied Materials (AMAT-NASDAQ, NR), TSMC (2330-TSEC, NR), Tokyo Electron (8035-TYO, NR), and KLA Corp (KLAC-NASDAQ, NR) all point to a bottoming of the cycle and a much more constructive outlook for 2020. All the aforementioned stocks are close to or at all-time highs while Photon’s shares are down ~46% from its summer 2018 high.
On the earnings power front, Q219’s EBITDA of $1.2M is the trough in our mind. We expect that in an upcycle, PHO’s quarterly EBITDA will surpass last year’s Q218 peak of $5.1M with minimal capital investment. That implies current valuation of 21.2x trough EBITDA and 5.0x peak EBITDA. We believe the Company’s products are still not fully entrenched within its customer base, providing for further growth beyond industry dynamics (and beyond its last peak!).
Q319 results point to an uptick in activity: The Company’s strong earnings beat and
conference call in early November reflect the increased industry confidence. Concretely, the Company announced (i) the cancelling of plans to shut down its production facilities for two weeks during the vacation period, as well as (ii) its intention to deliberately build inventory through Q419 ahead of an active 2020. Both the latter moves are tangible and definitive signs that rosier days are indeed ahead.
Sales/EBITDA came in at $8.7M/$2.4M (27.9% margin), up 23.0%/102.7% sequentially from trough Q219 levels. We went into the quarter calling for sales/EBITDA of $7.5M/$1.4M(18.3% margin). The Company had guided to sales of $6.5-8.5M and EBITDA margins of 17-21%. The increase in revenues was partly driven by a new supplier in Asia building inventory as well as improving market conditions in the semiconductor industry. EBITDA outperformance was namely due to the sales beat and exceptional cost control. GM% came in at a strong 54.8%, in line with last quarter, while opex came in $0.6M lower than last quarter’s $3.0M.
The Company’s free cash flow came in at an impressive $3.8M during the quarter (includes a $1.7M working capital contribution) vs. last quarter’s -$1.8M (includes a -$2.3M working capital drag). Cash balance ended at $34.0M (vs. 31.4M last quarter) on the positive free cash flow.