Posts record Backlog & Stock Hits New Highs
This month we update Photon Control Inc. (TSX-V: PHO) which was recommended this time last year in the $0.82 range and at the 2016 Outlook in the $0.64 range and to our clients at $0.46. Today, we are happy to report the stock continues to hit new highs, recently closing at $2.45 – gains of over 400% since our original recommendation.
Photon Control Inc. designs, manufactures and distributes a wide range of optical sensors and instruments to measure temperature, pressure, position, and flow. These products are used by original equipment manufacturers as well as end users in the semiconductor (90% of current business), energy, and manufacturing industries.
Industry: Technology - Semiconductor Tech
Recommended: December 2014
Recommendation Price: $0.46
Current Price: $2.45
Market Cap: $266,067,770
Shares Outstanding: 110,861,571
Fully Diluted: 114,684,635
Semiconductor Industry (Optical Sensors)
Semiconductors have revolutionized the way we work, communicate, travel, entertain, and live. As a building block of technology, semiconductors will continue to enable innovation and transform industries. With the accelerating pace of new chip capabilities and more applications, chip makers will need to increase production to meet this growing market. Simultaneously, semiconductor companies are regularly transitioning to new design and production technologies. Many of these technologies increase the number of process steps requiring more overall WFE production capacity. Thee combination of overall semiconductor growth and increased demand for equipment is expected to in turn drive growth for the company. Photon Control’s primary vertical in this market is in etch, one of many manufacturing steps in the process of creating semiconductors. The company works in and is developing business plans to meet demand in several other process steps including expanding its revenues from the deposition step as well as extending its product reach into the processes involved in the manufacturing of Organic Light-Emitting Diode (OLED) panels and other sophisticated display panel technologies, the fabrication of which is similar to the process for semiconductors.
Q1 2018 Results
Semiconductor revenues for first quarter rose 17% over the prior comparable period. The increase is attributable to the company capturing an increased share of its customers’ spend and continued robust market conditions persisting in the semiconductor industry.
Net income before tax for the quarter was $5.0 million compared $2.36 million in 2017 due to strong market conditions in the semiconductor industry and the completion of non-recurring activities in 2017, as described elsewhere.
EBITDA is defined as earnings before finance income, accretion expense, income tax, depreciation, amortization and foreign exchange (gain) loss. For the comparative period, EBITDA was further refined to remove the effect of non-recurring items, including corporate changes and Photon R&D settlement. EBITDA for the three months ended March 31, 2018, decreased to $4.72 million compared to $4.91 million in the comparable period in 2017 due to a higher staff complement to support current and future growth of customers.
Record Order Backlog
Order backlog was $24.7 million on March 31, 2018, an increase from $18.3 million at December 31, 2017, and $11.0 million at March 31, 2017. Order backlog represents the unfulfilled value of sales orders received and scheduled for fulfillment in the remaining rolling 6-month period. The increase in the order backlog reflects the continued demand growth in the semiconductor industry and early results from investments made in sales & marketing and engineering.
Business Outlook for the Second Quarter of 2018
Management provided Q2 2018 guidance with its first quarter results stating they expect revenue to be in the range of $14 to $16 million, tremendous growth over the $8.88 million reported in Q2 2017. For the full year, the company remains confident that they will outperform the consensus estimates of low double digit revenue growth for the semi- conductor equipment market. The company also expects to maintain its EBITDA and net income margins for the year at levels similar to or above those reported in the prior year.
Valuation and Fair Value Assessment
Photon’s trailing PE is in the range of 33 which is now at a premium to the market average multiple, but the true earnings potential is masked somewhat by the recent non-recurring items. The company boasts a very strong balance sheet with zero debt and a cash balance of $34.4 million, or $0.31 per share. If we strip this out of the company and use an annual EPS figure of $0.11, which is the consensus earnings estimate for the company over the next 12-months, its price-to-earnings based on the core business is around 15.8 – which is below the market average PE. The company could support an EV/EBITDA multiple in the range of 14-15 or a PE of 18-19 which would put the fair value in the $2.35-$2.50 range near term – roughly the current stock price. As the company grows we continue to adjust the near-term fair value higher. If it were to become a takeover target fair value would be substantially higher.
The company’s Q1 2018 results were strong. The record backlog continues to be positive near term. It is a result of three factors:
- Organic Growth: Growth from serving customers is very strong as the demand for silicon based products continues to drive increasing spending for wafer fab equipment.
- Market Share Growth: Customers are telling the company that Photon Control is achieving a growing share of their fibre optic share sensor spend.
- New Product Introductions: Reflects orders for new products introduced in the past few quarters, something Photon Control has not seen in quite some time. The company expects new product backlog (although small now) to grow through 2018 and beyond.
Q1 2018 results and the backlog growth reflect the shift in the semiconductor equipment market towards an increased adoption of Photon Control fiber optic sensors, and show positive results from internal investments. Management also reported that the company has committed $3 million towards a share buyback program. Finally, Photon Control submitted an application to graduate to the Toronto Stock Exchange and received approval. The company’s share now trade on the TSX.
Today, Photon Control serves just two verticals in the semi-conductor value chain - etch and deposition. The company provides just two types of process control measurements – temperature and position. Management believes the total addressable market for its products is currently $200 million which it has far from fully penetrated. Photon Control is the single largest provider in this segment. The company sees its total addressable market growing from current $200 million to approximately $600 million by 2021. This growth which goes well beyond market size in increases in etch and deposition, anticipates more touch points and measurements in those core markets as well as extending to additional verticals in the semi-conductor and solid state industries. The company believes the total addressable market for fibre optic sensors will also increase as the larger share of the semiconductor logic and memory devices manufactured shrink to approach the atomic length scale and become even more 3D. These advanced devices require more precise temperature measurements at more points to achieve target yields in fabrication. Precise measurements like those provided by Photon Control’s products, improve yields and fab yields equal pro t in the company’s industry. The equation is simple; more measurement points equals more yield which leads to more profit for the WFE’s the company supplies and in the end for Photon Control. Therefore, the company is currently investing in engineering and sales. These investments have already started to pay-off but are truly designed to allow the company to expand organically with new product editions for its customers.
With the company’s shares jumping over 400% since our original recommendation and over 200% since January last year, the stock is closer to fair value near term. But, the unexpectedly strong backlog should give the market confidence and potentially produce a higher multiple for the stock. Given the company’s strong backlog, balance sheet, history of profitability and relatively reasonable valuations, investors with a long-term outlook (2-5 years) should be rewarded over this time frame. The negative near-term forex situation has improved of late and while the year-over-year comparisons could still be slightly negative, the slump in the Canadian Dollar versus the U.S. Dollar is a positive. With better cost controls, less one-time items, and a record backlog, Q2 2018 should show stronger profitability. Near term, new clients could begin with a HALF POSITION. We maintain our Long-Term rating at BUY.