Ultra Clean Holdings is sitting on the fence

SweetBunFactory

Ultra Clean Holdings, Inc. (NASDAQ:UCTT) has been on a roll lately. The stock remained underperformed in the first half of 2022, but has outperformed the month of July. The stock also came close to completing what could have been a breakout at the end of the month, but the effort failed after the release of the most recent quarterly report, causing the stock to fall. Why will be covered next.

Why the Q2 report received poor reception from the market

The Q2 report wasn’t all bad. It actually came with many positives. For example, revenue and non-GAAP EPS exceeded consensus estimates. Q2 revenue grew 18% YoY to $608.7M, coming close to matching the record high. UCTT ended Q2 with net loss of $25M or $0.56 per share in GAAP terms and net income of $47.4M or $1.04 per share in non-GAAP terms, representing an increase of 5% YoY. The table below shows the numbers for Q2 FY2022.

Note that there was a charge of $56M or $1.24 per share in Q2 due to the divestiture of multiple businesses. This pushed the GAAP numbers into the red, but it is not included in the non-GAAP numbers. Non-GAAP earnings growth benefited from a lower tax rate of 15.2% in Q2 FY2022, down from 17.6% in Q1 FY2022 and 16.4% in Q2 FY2021. The non-GAAP weighted-average share count increased to 45.64M in Q2 FY2022, up from 44.25M in Q1 FY2022 and 45.59M in Q2 FY2021. Cash and equivalents stood at $421M at the end of Q2, down from $466M at the beginning of FY2022.

(GAAP)	Q2 FY2022	Q1 FY2022	Q2 FY2021	quarter by quarter	Year after year
revenue	$608.697 million	$564.144M	$515.200M	7.90%	18.15%
total profit	19.4%	20.2%	19.4%	(80bps)	,
operating margin	(0.9%)	8.1%	6.2%	(900 bps)	(710bps)
Income from Operations (Loss)	($5.511M)	$45.711 million	$31.947M	,	,
Net Income (Loss) attributable to UCTT	($25.093 million)	$27.930M	$17.098M	,	,
eps	($0.56)	$0.61	$0.39	,	,
(Non-GAAP)
revenue	$608.697 million	$564.144M	$515.200M	7.90%	18.15%
total profit	20.3%	20.5%	21.2%	(20bps)	(90bps)
operating margin	11.1%	10.9%	11.7%	20bps	(60bps)
income from operations	$67.390 million	$61.633 million	$60.430M	9.34%	11.52%
Net income	$47.415 million	$43.325 million	$43.678 million	9.44%	8.56%
eps	$1.04	$0.95	$0.99	9.47%	5.05%

Click to enlarge

Source: UCTT Form 8-K

However, Q3 guidance was a different story as it turned out to be worse than expected. The consensus estimate expected non-GAAP EPS of $1.23, but the actual number was significantly lower. Guidance for revenue of $585-645M for Q3 FY2022, an increase of 11.1% YoY over the midpoint. The forecast expects GAAP EPS of $0.32-0.55, a decline of 37.9% YoY at the midpoint and non-GAAP EPS of $0.94-1.18, a decline of 0.9% YoY at the midpoint. The wide range in guidance is a reflection of the high degree of uncertainty UCTT is facing, especially with supply chain disruptions quite common these days.

	Q3 FY2022 (Guidance)	Q3 FY2021	Year after year
revenue	$585-645M	$553.7M	5.65-16.49%
GAAP EPS	$0.32-0.55	$0.70	(21.43-54.29%)
Non-GAAP EPS	$0.94-1.18	$1.07	(12.15) -10.28%

Click to enlarge

Guidance didn’t expand in Q4, but management did add some color to the rest of fiscal 2022. UCTT expects growth to continue as demand remains strong. From the Q2 earnings call:

“For the second half of this year, we reiterate our belief that 2022 will be another year of growth for the WFE market and UCT. Broad-based rational spending supporting leading and trailing edge equipment has kept demand high. While some customer order flows and delivery schedules have been adjusted in the following quarters to align with ongoing supply chain constraints and capacity limitations, we have not seen any significant cancellations.”

A transcript of the Q2 FY2022 earnings call can be found here.

Management is excited about the outlook going forward. While UCTT acknowledges that there is weakness in some segments of the semiconductor market, other segments are strong.

“Our outlook for 2023 remains favourable. While there are signs of potential weakness in PCs, low-end smartphones and some consumer electronics, they are being offset by strong demand in the high-performance computing, IoT, robotics and automotive sectors. Today, the chip industry powers most aspects of our economy, so it is far less vulnerable to a single retail end market, and so is UCT. ,

These comments from UCTT are reassuring in light of recent concerns about the health of the semiconductor market. There are increasing reports suggesting a reduction in demand for semiconductor chips, which will undoubtedly have negative implications for suppliers of the equipment needed to manufacture those chips.

According to the most recent Form 10-K, UCTT received 64% of FY21 sales from Applied Materials (AMAT) and Lam Research (LRCX), the two largest suppliers of semiconductor manufacturing equipment. Thus UCTT is heavily dependent on a healthy semiconductor market to drive sales and profits. UCTT will need strengthening in some market segments to offset weakness elsewhere.

Nevertheless, it is noteworthy that many big-name semiconductor companies have reported declining demand for certain types of semiconductors, particularly those used in smartphones and PCs. For example, both Intel (INTC) and Qualcomm (QCom) recently issued pessimistic guidance, citing weakness in demand for PCs and smartphones.

Suppliers of semiconductor manufacturing equipment have greatly benefited from plans to expand the production of semiconductor chips. In fact, the bullish case for UCTT rests on the assumption that this expansion will continue unabated. However, weakness in demand for products such as PCs and smartphones has convinced some manufacturers to change these plans.

SK Hynix, for example, has postponed its planned $3.3B expansion of the memory chip fab. If more fab projects are delayed or even canceled, less semiconductor equipment will be required than the likes of AMAT and LRCX. If both see a dip in demand, UCTT will also be affected as most of its sales come from these two companies.

stock gets rejected

The stock fell 7% in response to the latest guidance and was even down as much as 12% at one point. The decline came after a powerful rally that saw the stock rise 34% after a low on July 1 and in the weeks before the release of the Q2 report. The rally was helped somewhat by the imminent passage of the CHIPS Act in the US Congress. However, the latest reports seem to have put an end to the rally, at least temporarily. The chart below shows how the stock has risen in recent weeks after falling for most of 2022.

Source: finviz.com

Note how the recent rally was preceded by a long downtrend that lasted for months. In fact, the lows can be combined to form a descending trend line, which in turn forms the lower boundary of a channel. The stock was in the process of breaching the upper boundary of this channel, but the recent decline brought the stock back within the channel.

The channel is intact and it is pointing down, which suggests that if there is no breakout and the stock stays within the channel then the stock is likely to go lower. However, it is worth noting that the stock bounced back when it came close to falling below the 50-day EMA, which can be interpreted as a positive sign for bulls.

UCTT is on the fence at the moment. On the one hand, the stock remains stuck in a descending channel, failing to break the resistance imposed by the upper boundary of the channel. On the other hand, the stock is far out of breakout as it stays close to the upper boundary of the channel. It is true that the stock failed to break through the resistance last time, but if it goes for another attempt it may have more success. At the moment, UCTT is down 41% YTD.

UCTT has some cards

Guidance was soft and the charts are trending bearish, but UCTT is not without its strength. The valuation has also dropped along with the share price. UCTT is now trading at a discount to its 5-year average. For example, UCTT trades at 12 times forward earnings with a trailing P/E of 19. In comparison, the 5-year average is 22 times forward earnings. The table below shows the multiples of UCTT.

	UCT
market cap	$1.54B
enterprise value	$1.79B
Revenue (“TTM”)	$2,341.6M
EBITDA	$304.6 million
trailing p/e	19.45
Forward P/E	12.47
peg ratio	,
p/s	0.66
p/b	1.82
EV/sales	0.76
Previous EV/EBITDA	5.87
Forward EV/EBITDA	5.55

Click to enlarge

Source: Seeking Alpha

Investor Takeaway

UCTT’s latest report was a mix of good and bad, although the latter managed to undercut the former’s decision based on market reaction. On the one hand, Q2 results were better than expected and UCTT is upbeat about the state of the market. On the other hand, third-quarter guidance was light, leaving people concerned about where the market was headed.

The demand for semiconductor devices may still be there, but for how long no one has any idea. The fact remains that demand for some types of semiconductor chips continues to decline and it is possible that demand for other types may decrease in the near future. UCTT is banking on current strength in some market segments, which, while offsetting weakness in other segments, is not a guarantee. Some companies are already shelving some of their expansion plans, which does not bode well for the market. The semiconductor devices market may already be at its peak in the current cycle.

I am neutral on UCTT. The multipliers are lower than in recent times and UCTT is still on the rise, but earnings growth is heading in the wrong direction. Market demand is still there, but there are sure signs that the market is weakening and not consolidating. While the charts leave open the possibility of a rally in the short term, it is unlikely that the rally will continue if earnings falter due to a downtrend in the wafer fab equipment market.

Bottom line, long UCTT has its strengths, but there are more weaknesses. The market for semiconductor chips should improve to address concerns that people have about equipment suppliers and related names, including UCTT. While that is yet to happen, the only way out is with respect to the UCTT.

Source