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Why Advanced Energy Industries is a short

Publication Date: 05 Nov 2018 - By Abrar Hassan Saadi By Abrar Hassan Saadi
Actionable
Differentiated

Equity Fundamental Events Macro Equity USA Technology

Advanced Energy Industries (NASDAQ:AEIS) develops power products that transform electrical power into various usable forms. The firm’s primary markets are semiconductor capital equipment and industrial power sector. It has demonstrated strong fundamentals and top line growth for last four years, and the period has also been profitable for its peers. Everything was going good until the US-China trade war began to escalate, after Q2 earnings missed expectations while Q3 guidance was given below consensus, the stock went down 5%.

Although fundamentals look good for both the semiconductor equipment and industrial power industry in the medium to long term, macroeconomic impact dominates fundamentals at this point in time. Uncertainty in the semiconductor sector due to cyclicality, weakness, pricing pressure and trade-war escalation is affecting AEIS and similar firms. My discounted cash flow model (DCF) model indicates that the intrinsic value of AEIS is $38.33, implying an overvaluation of $8.17 a share (AEIS trading at $46.5). Relative value suggests mixed results. Incorporating my valuation with the expected uncertainty in semiconductor industry, AEIS is a short.

Performance analysis

AEIS has demonstrated good fundamentals in last four years, sales growth have averaged 23%, along with 5.35% in bottom line margin and 23%+ in FCF margin. But further investigation indicates considerable volatility in the trends, reflecting the cyclical features.

Let’s take a comprehensive look at AEIS by analysing the performance spreads. In last two years AEIS has particularly demonstrated industry-above strength in performance, but the magnitude of changes clearly indicate inherent volatility in the industry, which is passed on to AEIS.

Performance spread

*AEIS minus comps average

2012

2013

2014

2015

2016

2017

Gross margin

0.85%

10.35%

11.87%

12.25%

12.32%

9.57%

EBITDA margin

-0.37%

-1.72%

5.78%

-36.47%

14.37%

6.80%

EBIT margin

-1.11%

-0.86%

6.27%

-34.92%

16.25%

8.75%

Profit margin

-1.62%

3.80%

3.57%

-35.98%

16.77%

5.92%

FCF margin

10.83%

1.77%

7.63%

11.40%

15.26%

8.21%

Valuation

My DCF model indicates that AEIS’s intrinsic value stands at $38.33, implying an overvaluation of $8.17 per share. The intrinsic value also represents the upside associated with the short, implying an upside of 19.72% without transaction costs.

DCF Summary

 

Total PV of Unlevered FCF

331,833,809

Cost of equity

8.00%

Terminal year Unlevered FCF

65,735,535

After-tax cost of debt

6.00%

Perpetual growth rate

2.00%

Equity weight

100.00%

Terminal value

1,117,504,100

Debt weight

0.00%

PV of terminal value

760,554,513

WACC

8.00%

Implied Enterprise value

1,092,388,322

 

 

Less: Total Debt

0

 

 

plus: cash and cash equiv

407,283,000

 

 

Implied Equity Value

1,499,671,322

 

 

weighted avg shares

40,176,000

 

 

Intrinsic value

38.33

 

 

Market Price

46.50

 

 

Overvalued(Undervalued)

8.17

 

 

Implied upside

17.58%

 

 

Intrinsic value’s sensitivity to perpetual growth rate

Sensitivity analysis indicates that AEIS would begin to appear undervalued if perpetual growth rate outlook is beyond 4%, which is 200 bps more than my estimate.

Relative value shows mixed results- P/E and EV/EBITDA suggests undervaluation while P/B suggests the opposite

Ticker

Company Name

Market Cap

PE Ratio

Price/Book

EV/EBITDA

 

AEIS

Advanced Energy Industries, Inc.

$1.82B

12.69

3.07

8

MKSI

MKS Instruments, Inc.

$4.1B

10.83

2.28

8.23

COHR

Coherent, Inc.

$3.22B

13.34

2.62

7.58

UCTT

Ultra Clean Holdings, Inc.

$428.29M

4.76

0.96

5.34

NVMI

Nova Measuring Instruments Ltd.

$675.53M

14.85

2.55

9.76

BRKS

Brooks Automation, Inc.

$2.14B

17.3

3

17.76

   

Average

12.30

2.41

9.45

AEIS faces a number of financial and business risks. On the financial front, the firm is exposed to interest rate risk and foreign currency exchange risk. As of 2017, the firm’s investment portfolio consisted primarily of certificates of deposit with maturity of less than 1 years. The short term maturity is helpful for managing default risk, market risk, and reinvestment risk. The firm’s functional currencies primarily include the USD, EUR, KRW, TWD, GBP, and CNY while purchasing and sales activities are primarily denominated in the USD, JPY, EUR and CNY. Adverse move in currency exchange could impact the firm.

The effect of foreign currency translations on cash had a $2.2m favorable impact for the year ended December 31, 2017 compared to a $1.9m unfavorable impact for the year ended December 31, 2016. Escalation of US-China tradewar is current the prime business risk. Although AEIS has less than 6% of the sales generated from China, there was significant sales growth expectation from China (before tradewar escalation). As a result, the market increasingly factoring the tradwar into AEIS’s pricing.

Conclusion

Expected weaknesses in semiconductor industry along with pressure from trade war is reflecting increasing uncertainty for AEIS. Combining the performance factors, along with valuation, industry structure, and risks, AEIS is a short. Investors can effectively manage their exposure with available call options.

Negative from trade war and cyclicality could drive down AEIS's price towards its intrinsic value, as a result, AEIS is a short.

Disclosure:

I have no positions in any of the securities referenced in the contribution

I do not use any non-public, material information in this contribution

To the best of my knowledge, the views expressed in this contribution comply with UK law

I agree with the terms and conditions of ReachX

This contribution is for informational purpose and does not constitute investment advice nor is it an offer to sell or buy, nor is it a recommendation for any security.

Abrar Hassan Saadi

 

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