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Monday, October 9, 2017

Ichor Holdings – Cheap Small Cap Missed by Wall Street’s Radar

  • Ichor share price does not make much sense after performing a discounted cash flow analysis.
  • The company is producing some of the most complex subsystems needed by semiconductor manufacturers.
  • The stock has already soared this year but we think substantial upside potential remains.

Ichor Holdings (ICHR) has gone up well over 100% for the year.  Despite this the stock still appears grossly undervalued even if we assume little growth.  In reality growth expectations are not low at all for this semiconductor equipment company.  Recommending stocks after such a strong rally is not generally something we would consider but Ichor’s current valuation, to be discussed below, makes us confident that this is still an attractive opportunity for new investors. 


Products

Ichor is a $658 million dollar company involved in the design and manufacturing of fluid delivery systems for equipment used in semiconductor manufacturing.  The main products include gas and chemical delivery subsystems which are key components of tools used in the manufacturing of semiconductors.  The gas delivery subsystems deliver, monitor, and control precise quantities of specialized gases used in semiconductor manufacturing processes such as etch and disposition.  The chemical delivery subsystems blend and dispense the reactive liquid chemistries used in semiconductor manufacturing processes such as chemical-mechanical planarization, electroplating, and cleaning.  Finally, the company also manufactures components for use in fluid delivery systems.

Most semiconductor OEMs outsource the design and manufacture of their gas delivery subsystems to a few specialized suppliers such as Ichor.  Increasingly OEMs are also outsourcing the design and engineering of chemical delivery subsystems as a result of the increased fluid expertise required.  Ichor will continue to benefit as this outsourcing trend continues.  The OEMs benefit by outsourcing the work related to these fluid delivery systems if it allows them to reduce the fixed costs and development time.  In its latest 10K, Ichor says its clients include two of the largest manufacturers of semiconductor capital equipment in the world, Lam Research (LCRX) and Applied Materials (AMAT).  The company frequently has its engineers working at its customer’s sites to engage with their product design teams.  This allows the company to build subsystems to meet the exact specifications of the customer and often allows them to be the sole supplier of these subsystems during initial production ramp up.

Company Overview

Ichor has a 17 year history in which it developed deep capabilities in designing and building gas delivery systems.  The company has a global footprint with facilities located close to its customers.  This has allowed the company to establish long standing relationships.  Over two decades, the company has been developing complex fluid delivery subsystems to meet the constantly changing production requirements of semiconductor OEMs.  They have significant capacity in Singapore to support high volume products.  The two companies mentioned previously, Lam Research and Applied Materials, were the two largest customers by sales in 2016.  Sales from continuing operations grew by an impressive 40% to $405.7 million in 2016 with net income coming in at $20.8 million. 

Ichor’s engineering team is made up of chemical, mechanical, software, and systems engineers.  Their engineering teams work directly with their customers’ product development teams to provide technical expertise outside their core competencies.  The company seeks to use its long standing relationships with two of the market leaders to locate new business opportunities created as a result of industry consolidation.  The assembly and integration of high purity gas and chemical delivery systems happens at the company’s locations in Singapore, Tualatin, Oregon, and Austin, Texas.  The company also has a facility in Malaysia for components used in the gas delivery subsystems and in Union City, California for components using in chemical delivery subsystems.  These facilities are located in close proximity to customers.

One of the key elements that make Ichor an attractive investment is the relatively low rate of capital expenditure.  The company is able to grow sales with a low investment in property, plant and equipment.  The company also highlights its close supplier relationships which allow it to scale up production quickly without maintaining a lot of excess inventory.  Risk is reduced by this low fixed cost approach since it minimizes the impact of cyclical downturns on net income.  We prefer this conservative approach even though it results in a smaller increase in gross margin as a percentage of sales in times of increased demand.

Fueling Growth

The company acquired Ajax United Patterns and Molds in April of 2016.  This acquisition is what allowed Ichor to offer chemical delivery subsystem capabilities to its existing customers.  The Ajax acquisition enabled Ichor to manufacture complex plastic and metal products required by the medical, biomedical, semiconductor, and data communication equipment industries.  As a result of deploying more leading edge tools, the company will grow its business as OEMs will need to refurbish legacy systems.

More recently the company acquired Cal Weld, a leader in metal component manufacturing which is considered a strategic business for Ichor.  The acquisition cost was $50 million of which $20 million was paid in cash and the rest borrowed.  It expands capacity and capabilities in the component manufacturing area for gas delivery tools in semiconductor manufacturing.  Cal Weld supports key semiconductor tools such as deposition and etch.  The Cal-Weld facilities are located in Fremont, California and Tualatin, Oregon.  Cal Weld is expected to generate between $65 million to $80 million in revenue next year.


While there is currently a risk posed by customer concentration, the company is seeking to expand its customer base within the fluid delivery market.  The recent annual report mentions that Ichor was selected as a manufacturing partner for a provider of etch process equipment that was previously not a customer.  The company is also planning to diversify its sales exposure and leverage its current capabilities by acquiring new products and solutions for high growth applications in new markets such as medical, research, and energy.

In the second quarter earnings call the company sounded very optimistic on continued growth noting that they are seeing increased business beyond the two largest customers.  The company said its third and fourth largest customers are expected to grow 100% this fiscal year. One of these customers asked Ichor to redesign their gas delivery systems for better performance and lower cost.

Risks

Clearly one concern for Ichor is that the semiconductor equipment OEMs could start developing the gas or chemical delivery subsystems internally.  Otherwise, the primary competitor is Ultra Clean Technology for gas delivery subsystems.  The chemical delivery subsystem industry is highly fragmented as is the tool refurbishment market. 
As a result of the customer concentration issue mentioned previously, the clients have a significant amount of negotiating leverage which could lead to price and margin pressure.  Additionally, the company will be impacted by any decline in semiconductor sales or the various electronic products requiring semiconductors. 

One more unique concern is the fact that Ichor is a largely controlled by a single investor, Francisco Partners, which owned over 74% of the outstanding shares at the time of the last annual report.  This is a board governance issue since it means that Francisco basically controls who is elected to the board of directors which could mean that the interests are not always aligned with the interests of other shareholders. 

Also, keep in mind is that the company is incorporated in the Cayman Islands and Cayman Islands law provides less protection for shareholder interests compare to the laws of the United States.  Another drawback that comes along with investing in a company that only recently became public is that there is not the same level of historical data available as compared with companies that have been public for an extended period.  The company provides financial statements going back to 2014 which will be discussed in sections that follow.

Financials & Valuation

 The balance sheet is not ideal given that retained earnings, or in this case accumulated deficit, are negative and there is some long term debt even if it is not an unreasonable amount.  While there is currently still an accumulated deficit the value will not be negative for long if the current pace continues as seen in the table below. 

Source: barchart
The current ratio comes in at an acceptable 1.80 and long term debt to equity stands at 0.22.  A clear positive is seen when looking at the income statement where we see incredible sales growth in the last three years as well as the last few quarters.  We also like the way the annual cash flow numbers are looking where cash flow from operations easily covers capital expenditures and even the 2016 acquisition.


Source: barchart
Looking more closely at recent results, it should be noted that we are seeing some margin pressures.  For the quarter ending in June, although sales increased, net income actually decreased as a result of increases in the cost of goods sold and operating expenses.  The table below shows cost of goods sold and operating expenses as a percentage of revenues.  One part of the drop in income not shown in the table is the negative contribution of -$610,000 from discontinued operations.

Source: barchart
Next, we will take a quick look at our discounted cash flow model.  Rather than use the trailing twelve month EPS of $3.64, we will use the lower EPS estimate for next year which is $2.79.  We rather use the lower of the two numbers to keep the model slightly more conservative.  The current forward P/E is 9.46.  We think this is unreasonably low in comparison to the industry and market in general and will use a future P/E ratio of 15 in the model.  Finviz  provides an optimistic long term EPS estimate of 29.25%.  Earnings did grow by 310% on a quarter over quarter basis.  Keep in mind that this is at least partially related to the acquisitions mentioned above.  We will not use either of these growth numbers in our DCF model.  Instead we will adjust the required long term growth rate until the model shows that the current price is equal to the target buy price.  In this way, we see the growth rate that would be required to get the return on investment we are looking for.  The DCF model inputs are summarized below:

  • ·         EPS estimate for next year: $2.79
  • ·         Future P/E ratio: 15
  • ·         Discount rate (desired annual return):  10%
  • ·         Long term annual EPS growth rate:  1%  (Read notes below)

Again, the long term EPS growth rate used above is not what we actually expect the growth rate to be.  This is just the calculated growth rate required to make the current price equal to our target buy price.  Basically, the model is showing us that the stock is grossly undervalued if one actually believes the analyst estimates or assumes any kind of substantial growth from here like we do.  Despite the massive run up since the IPO, the DCF model makes us think there is still plenty of room to the upside.  The table below provides some key valuation and financial metrics for Ichor.


Source: finviz

Final Thoughts


Clearly the right thing to do was buy the shares at the IPO price or anytime at the beginning of the year since the stock has already gone up well over 100% for the year.  However, this does not mean it is too late to initiate a position.  In the case of Ichor, we think there is still plenty of room to the upside from here based on the discounted cash flow model and growth prospects.  We rate Ichor a buy.  Unfortunately, a buy-write strategy is not a possibility since there are no options available for this stock.  Of course, we do not think this is a reason to ignore Ichor given the significant undervaluation.  The potential of this small cap company, with a market cap of $661.83 million, appears to be going unrecognized by the market and it may make sense to buy before it starts getting the attention it deserves.  Finally, keep in mind that other companies in the space like Ultra Clean Holdings (UCTT) trade at much higher multiples.

Thursday, October 5, 2017

Infosys Ltd ADR (NYSE:INFY)


  • The stock is over 13% off its 52 week high in an overreaction to recent headwinds.
  • Infosys is making a strategic shift to providing its own innovative technology solutions rather than simply fulfilling orders.
  • A company with this type of client list, positive strategic shift, and dividend yield deserves a closer evaluation.

Read the Full Seeking Alpha Article HERE

Monday, October 2, 2017

DST Systems, Inc. (NYSE:DST)


  • The recent decline in the share price is providing investors with a good entry point.
  • We think the company will overcome the recent headwinds and realize the projected synergies from the recent acquisitions.
  • Our discounted cash flow model shows that the shares are undervalued using relatively conservative growth estimates.


Read the Full Seeking Alpha Article HERE

Monday, September 25, 2017

NIC Inc. (NASDAQ:EGOV)


  • NIC’s share price is down over 28% for the year and has reached value territory.
  • We believe the company has sufficient opportunities for growth available in the government digital services space such that substantial upside potential exits from here.
  • The company is undervalued based on our discounted cash flow model using fairly conservative earnings growth forecasts.

Read the Full Seeking Alpha Article HERE

Monday, September 18, 2017

Eaton Corporation (NYSE:ETN)


  • Investors that did not take advantage of the overreaction to the second quarter earnings miss can still acquire the shares at a discount to fair value.
  • The company is trading at a discount based on our conservative DCF model, which uses a long term EPS growth rate well below that provided by analysts.
  • Lock in the 3.12% dividend and own shares in a power management powerhouse with a diverse portfolio of specialized products sold to a broad array of customers.

See the Full Seeking Alpha Article HERE

Monday, September 11, 2017

Advanced Energy Industries, Inc.(NASDAQ:AEIS)


  • Advanced Energy is a company that has achieved something rather rare, impressive growth with no long-term debt.
  • The balance sheet is very strong, and cash flow has been equally impressive.
  • When a great company is even slightly undervalued, it can make sense to initiate a position, so we rate the company a buy.

See the Full Seeking Alpha Article HERE

Monday, September 4, 2017

Open Text Corp (NASDAQ:OTEX)


  • OpenText has a track record of identifying great acquisition targets, acquiring them at a fair price, and successfully integrating the acquired companies.
  • The company offers an ever more diverse set of solutions to a growing and already impressive customer base.
  • Even if the company only grows earnings at half the rate of analyst estimates or its average historic growth rate, it is undervalued at the present time.
See the Full Seeking Alpha Article HERE