- 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.
Source: Ichor
Presentation
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.
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