Amidst Industry Turbulence, Veeco Instruments Still Seeing Solid Demand

I don't think it's much of a stretch to say that the tech market has been volatile over the past six months or so, and smaller-cap names have generally fared a little worse than their larger brethren. In that context, Veeco Instruments' (NASDAQ:VECO) 14% decline since my last update (versus an 18% decline at Applied Materials (AMAT), 12% at ASML (ASML), and 10% at Lam Research (LRCX)) isn't too awful, though this is a tough stock to benchmark and comparisons to these much larger tool companies are of limited value.

Investor sentiment for the chip space may not be what it was, but the reality is that fabs are still looking to spend large sums to increase capacity, particularly at leading-edge nodes. Moreover, Veeco continues to have attractive leverage to emerging opportunities like extreme ultraviolet (or EUV) lithography, multiple gallium-based substrates, and advanced tool/technology adoption in areas like microLEDs, power semis, and storage.

I'm a little less bullish on the near-term margin outlook for Veeco given supply-chain and mix pressures, and that does take a toll on my cash flow-based and margin-based fair value estimates, but I think the overall outlook for this under-followed equipment supplier is still positive and it's a name worth considering.

 

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Amidst Industry Turbulence, Veeco Instruments Still Seeing Solid Demand

Veeco Coming Through With Orders And Strengthening Its Enabling Tools Argument

 

Small-cap semiconductor tools company Veeco Instruments (VECO) continues to do its part, delivering better than expected revenue and order growth and strengthening its case as a supplier of important enabling tools for leading-edge semiconductor production. What’s changed since my last update is the extent to which the Street has taken notice – Veeco shares have climbed around 30% since that last article, handily beating larger tool companies like ASML (ASML), Applied Materials (AMAT), and Lam Research (LRCX).

I continue to like where Veeco is positioned. The company is gaining traction with its laser spike annealing (or LSA) tools and could see further adoption in memory chip production, and the company is likewise well-positioned with its ion beam and MOCVD tools in other growth markets. Valuation isn’t quite as compelling as it was 30% ago, but I still see double-digit annualized return potential here and the possibility of further positive revisions to guidance/expectations.

 

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Veeco Coming Through With Orders And Strengthening Its Enabling Tools Argument

Veeco Instruments Leveraging Increased Demand Well, But The Market Doesn't Care

 

When good news from a company, a small company in particular, runs up against a rising tide of negative sentiment, it’s almost always the tide that wins. Veeco Instruments (VECO) has been delivering, with beat-and-raise quarters, improving order/revenue outlooks, and improving margins, but the market is not rewarding the stock for it, and Veeco isn’t the only player in semi tools that’s been weak in recent months.

The market is going to do what the market is going to do, but I do believe the shares are undervalued below the mid-$20s. In addition to near-term opportunities in the core business, including more tool sales for advanced packaging, I see longer-term opportunities in memory and compound semiconductors. Moreover, I believe management is continuing to build credibility with its margin improvement efforts, and the upcoming virtual analyst day is an opportunity to provide some new multiyear targets.

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Veeco Instruments Leveraging Increased Demand Well, But The Market Doesn't Care

Weaker Margin Guidance Overshadowing Progress At Veeco Instruments

 

I’ve written this several times in the past, but it bears repeating – margins matter more in sectors like semiconductor equipment than some analysts and investors believe. Semi equipment company Veeco (VECO) is doing pretty well from a revenue and order flow perspective, and I believe the business is on the cusp of meaningful acceleration, but weaker margin guidance weighs on valuation in the near term and has driven underperformance since my last update.

Veeco is a company that has long struggled to get its ducks in a row, but I believe the outlook is bright. In addition to a strong-moat position in data storage, Veeco has growth opportunities in areas like annealing, EUV mask blanks, GaN chip production, and chip packaging that shouldn’t be ignored. The shares need better margin momentum to outperform, but in a sector that offers few bargains, Veeco is worth a look on its leverage to ongoing capacity expansion spending.

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Weaker Margin Guidance Overshadowing Progress At Veeco Instruments

Veeco Instruments - Brief Hiccup In Margins Doesn't Change The Positive Long-Term Story

Veeco Instruments (VECO) is never going to be the easiest, cleanest, or most popular semiconductor tools story, and that’s okay. Relative to companies like Advanced Energy (AEIS), ASML (ASML), or VAT Group (OTCPK:VACNY), Veeco is more of a “hodgepodge” of tools and end-market opportunities, but while that story may lack some elegance and simplicity, the growth markets are nevertheless real and complemented by underlying execution that has meaningfully improved in recent years.

With momentum in areas like LSA, tools for 5G filters, and data storage, and longer-term opportunities in areas like EUV mask blanks and VCSEL production, I continue to like these shares. The stock has done well since my last update, underperforming the exceptional move at Applied Materials (AMAT), but doing pretty well compared to a lot of other tool companies. With better visibility on revenue growth and margin improvement over the next few years, I see a good argument for a mid-to-high $20s price over the near term.

 

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Veeco Instruments - Brief Hiccup In Margins Doesn't Change The Positive Long-Term Story

The Gap Between Veeco's Improving Outlook And Market Perception Is Too Wide

There are valid reasons to be skeptical of Veeco Instruments (VECO) – the company has lost market share over the years in most of its businesses and the growth opportunities could be dismissed by casual observers as a “hodgepodge” of small niche applications. The thing is that multiple $100M/year “niches” add up to something meaningful for a company with around $450 million in revenue, and the market may well be underestimating the company’s ability to gain and hold share in meaningful tool markets like EUV mask blanks, LSA, microLED, compound semis and hard drives.

I started warming up to these shares last quarter, and with the underperformance since I’ve taken a small position. I think these shares should be trading closer to $15 today on the basis of pretty solid opportunities in EUV mask blanks, 5G RF filters and hard drives, and I see upside to $20 on improving, but certainly “at-risk”, results in areas like LSA, VCSEL and microLED production, and compound semis.

 

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The Gap Between Veeco's Improving Outlook And Market Perception Is Too Wide

Veeco Benefitting From Diversification, And Waiting For Orders To Rebound

If you like to trade, Veeco (VECO) may hold some appeal, as the shares seem to like to range between the high single-digits and mid-teens. From the perspective of a long-term investor, though, I continue to regard Veeco as a more middling prospect. The shares are up about 10% from my last article, when I thought the shares had some appeal/value, and have outperformed the chip space and many tool peers/comps, but now I consider the valuation to be more “fair” and the company’s longer-standing performance and competitive issues are more relevant.

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Veeco Benefitting From Diversification, And Waiting For Orders To Rebound

Veeco Looks More Interesting After A Big Pullback

Veeco (VECO) shares have remained quite volatile since my last update; volatility in smaller, under-covered semiconductor equipment names isn’t that unusual, and the coronavirus outbreak adds yet another factor to the mix. On the other hand, Veeco’s fourth quarter results were pretty good and the business seems to be on track to return to profitability later this year. Add in some interesting longer-term opportunities like tools for EUV mask blanks, VCSEL production, and GaN deposition, and I can see reasons for considering these shares.

Not unlike many other equipment providers, these shares have been hammered since Valentine’s Day, with the stock down almost a third from their high. Veeco isn’t my favorite name for many reasons, including the fact that I see it as more of a hodgepodge of tools and market opportunities and I question the long-term margin potential, but there’s a fair price for all going concerns, and I think Veeco is likely trading below that price now.

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Veeco Looks More Interesting After A Big Pullback

Veeco Seeing New Opportunities Develop, But Valuation Is More Equivocal

Veeco (NASDAQ:VECO) has definitely had its challenges, as the company has not only had to deal with a slowdown in the semiconductor industry but also a significant shift in its long-term end-market opportunities. Veeco has turned away from the LED tool business that was quite significant to the company and has instead embraced emerging opportunities in EUV, VCSEL, and hard drives, as well as maintaining the LSA and lithography businesses it acquired with Ultratech.

The extent to which Veeco can stitch together an attractive long-term opportunity from these new markets remains to be seen, but a greater focus on front-end semi tools should help margins. Profitability, too, remains challenging, with the company likely to report quarterly net losses into 2021. Valuation is something of a toss-up now, but returning to double-digit year-over-year revenue growth could bring some positive attention back to the shares.

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Veeco Seeing New Opportunities Develop, But Valuation Is More Equivocal

Veeco Showing Signs Of A Longer-Term Transition To A Better Model

Although I thought Veeco (VECO) was undervalued in November of 2018, I didn’t expect the strong rebound in the share price, and I definitely underestimated the Street’s enthusiasm for the changes management was making to the business. To be fair, it’s not just a change in perception that I believe has driven the share price move; I believe Veeco has a better strategy and business plan in place now, and I underestimated the growth potential that such a shift could bring into the picture.

Veeco’s decision to move away from commoditized markets like blue LED and embrace more front-end equipment (not to mention equipment that enables leading-edge chip production) should bode well for growth and margins. Exactly how much it will margins is a big question when trying to figure out the valuation. If the changes management has made can put the company in a position to generate long-term EBITDA margins in the 20%’s and FCF margins in the mid-teens, there could still be further upside from here.

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Veeco Showing Signs Of A Longer-Term Transition To A Better Model

Veeco Seeing A Cyclical Slump Exacerbated By End-Market Capacity Challenges

Veeco (VECO) has hardly been my favorite name in the semiconductor equipment and tool space, but I didn't expect another one-third drop in the price of the shares since my last update. While my worries about LED equipment demand seem to be playing out, weakness in advanced packaging is getting worse, and positive drivers like VCSEL and EUV tool demand seem to be playing out a little slower.

Whether it is companies/stocks like Veeco or Rudolph (RTEC) that I don't like so much or companies/stocks like Advanced Energy (AEIS) and VAT Group (OTCPK:VACNY) that I do like, it's tough to buy these stocks going into order weakness, as you never really know how steep the correction phase of the cycle will be. Although I do believe that Veeco looks undervalued even with a sharp revision to 2019 expectations, the possibility of further downward revisions can't be ruled out, and I don't like the risk/reward balance here.

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Veeco Seeing A Cyclical Slump Exacerbated By End-Market Capacity Challenges

Veeco Hit Hard As LED Orders Disappear

In the eight months or so since I last wrote on Veeco Instruments (VECO), this semiconductor and LED tool manufacturer has been on a wild ride. While the shares did spend about a month earlier this year above the fair value estimate of $17.50 I offered in that piece, the shares have since sold off sharply as my concerns about a peaking MOCVD market and inconsistent performance from the Ultratech acquisition seem to be coming to fruition.

My position on Veeco isn’t really all that much different now. I do believe the shares are undervalued, but I believe the traditional MOCVD market is only going to get more challenging and I’m not sure that opportunities like ion beam etch, MOCVD for VCSEL, and Ultratech’s advanced packaging, LSA, and metrology will be enough to fully compensate. Although I think there’s a valid case to be made that Veeco shares should trade in the mid-teens, I’d rather own stocks like Advanced Energy (AEIS) or VAT (OTCPK:VACNY) if I had to own something in the tool/semi equipment space today.

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Veeco Hit Hard As LED Orders Disappear

Rudolph Technologies Growing Into Expanding Markets, And Priced Fairly

Against a backdrop of generally weakening sentiment, Rudolph Technologies (RTEC) has been a bit of an outlier in the semiconductor equipment space. Up almost 30% over the last year, and over 20% year to date, Rudolph is solidly ahead of peers/rivals/comps like KLA Tencor (KLAC), Lam Research (LRCX), Applied Materials (NASDAQ:AMAT), Nova Measuring (NVMI), and SUSS Microtec (SMHN.XE). What makes that a little odd is that although the company has been steadily growing its addressable market, its revenue growth hasn't been all that outstanding on a peer-to-peer basis and its product exposures (RF, etc.) could be a vulnerability.

Rudolph has done a little better than I'd expected back in 2016, but compared to a stronger equipment environment than I'd expected the "net outperformance" hasn't been all that significant. Although I do like Rudolph's prospects for leveraging ongoing demand for advanced architectures and packaging, as well as its prospects to sell lithography stepper tools into the OLED space, the valuation seems pretty fair at a time when the overall sector is looking pretty wobbly.

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Rudolph Technologies Growing Into Expanding Markets, And Priced Fairly

Veeco Instruments Battered As Doubts Mount

This has been a lousy year for Veeco Instruments (VECO), as this supplier of tools for the LED and semiconductor markets has seen its share price cut in half on repeated earnings disappointments, an unexpected litigation outcome, and growing worries about the company's long-term margin and growth leverage. While the acquisition of Ultratech earlier in the year achieved the company's goal of diversification, it seems to be coming at the cost of even more volatility and uncertainty in the business.

I can see some upside in the shares from here, but it's not clear to me that it is worth the hassle and the risk. Veeco is going into 2018 with a strong backlog, but the MOCVD market could be approaching a near-term peak and serious emergent competition is eroding margins. In the advanced packaging and semiconductor businesses, Ultratech's historical volatility is continuing and there are no guarantees on the timing or magnitude of LSA or packaging-driven growth.

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Veeco Instruments Battered As Doubts Mount

Investopedia: Can LEDs Brighten Investor Portfolios?

Goldman Sachs recently highlighted LED lighting as a top “disruptive” theme over the next decade. While I'm often inclined to believe that these sell-side "theme pieces" are designed more towards generating attention during stretches of slow company news, I have little doubt that the penetration rate of LEDs in the lighting market is going to increase significantly over the next decade. That is going to fuel significant demand for LED-making equipment, LED packaging, and finished lighting fixtures for companies like Aixtron (Nasdaq:AIXG), Cree (Nasdaq:CREE), Philips (NYSE:PHG), and Osram What is less clear to me is the extent to which investors can expect to see huge gains at this point – the “LED revolution” has been long in coming and while there are certainly going to be trading opportunities come and go, the idea of “buy and hold” in this sector seems optimistic at best.

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Investopedia: Aixtron Is A Volatile Way To Play LED Growth

It's a stretch to say that LEDs are everywhere, but maybe not by much. LEDs are still generally too expensive for residential, commercial or municipal lighting, but pretty much every smartphone, tablet or notebook PC owner has an LED screen on their device, and likewise for many TV owners.

Given the considerable economic advantages, LED lighting is likely a "when, not if" proposition, and that should spur demand for the critical LED-making equipment that Aixtron (Nasdaq:AIXG) sells. The key question for investors, however, is whether the stock of a very volatile equipment maker like Aixtron is really the way to play the next run in LEDs.

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Investopedia: Good Luck Figuring Out Applied Materials' Course

It's common knowledge that the semiconductor industry is cyclical and that any company selling equipment for this industry is going to have its ups and downs. Even so, it almost feels like investors considering Applied Materials (Nasdaq: AMAT) would be better served with a Ouija board or tarot deck. Nobody questions that AMAT is a key player in the equipment used to make chips, solar panels, flat panel displays and so on, but it seems no two analysts or investors can agree on where we are in this cycle and how low the next bottom will be. 


A Solid Fiscal Second Quarter
What is certain is that Applied Materials had a solid second quarter. Revenue rose almost 7% on a sequential basis and surpassed the high end of its analyst range. Growth was led by the services and solar businesses, while the core semiconductor business was down about 3% from the prior quarter. Orders were also solid - climbing 7% - with growth everywhere but the solar business and the core chip equipment business matching that overall growth rate.

Going with straight-up GAAP reported results, AMAT saw gross margin improve more than a full point from last year, but come off about 70 basis points sequentially. Operating income was stronger on a year-over-year basis (up 75%), and up strongly on a sequential basis. To the extent that looking at cash flow can help resolve some of the non-cash items that complicate earnings reports, AMAT reported that year-to-date operating cash flow was up almost 26% from the year-ago period. (For more, see Strategies For Quarterly Earnings Season.)


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