It’s no secret that synthetic intelligence [AI] has been the expansion story for the 2020s. The worldwide AI market is predicted to develop at a strong tempo of 37.3% yearly to achieve about $1.7 trillion by the tip of 2030. One of many fundamental elements that makes AI potential is built-in circuits [ICs] (also referred to as semiconductors or microchips). What just isn’t as well-known is a rising firm that’s prone to profit from AI progress. Photronics (NASDAQ:PLAB) is among the behind-the-scenes firms that makes the manufacturing of semiconductors potential.

I see Photronics as a strong long-term funding because the inventory has a gorgeous valuation and the corporate has robust consensus anticipated earnings progress of about 13% for FY24.

Photronics manufactures photomasks that are used to supply ICs, flat panel shows [FPDs], and to switch circuit patterns onto microchips. The corporate is experiencing robust demand for its photomasks as report income was achieved for the sixth 12 months in a row.

Nonetheless, it’s value noting that Photronics acknowledged that there’s a present contraction in demand which can final by fiscal Q1 2024. Nonetheless, the consensus amongst business leaders and prospects is that demand shall be stronger by the mid-point of 2024 or the corporate’s fiscal Q2 & Q3 2024 as the subsequent progress section begins. The corporate additionally acknowledged that photomask demand tends to be much less cyclical than the semiconductor business normally. This offers Photronics some stability in a market that may fluctuate considerably.

Progress Catalysts

The marketplace for IC photomasks is approaching $4 billion yearly. The overall marketplace for each IC photomasks and FPD photomasks is $7.5 billion. Photronics is a pacesetter on this market with trailing 12 month income of $892 million with consensus expectations of $935 million in income for FY24 and $1 billion for FY25.

The robust anticipated progress for AI by the rest of the last decade is prone to create a pleasant tailwind for Photronics. The corporate is prone to see rising demand for its photomasks for AI-related semiconductors. Photronics’ prospects are prone to expertise an growing want for photomasks for producing their AI-related ICs in 2024 and past.

Circumstances look constructive for robust photomask pricing in 2024. There was a worldwide scarcity of photomasks available in the market, which might put upward strain on costs in 2024. The main photomask producers: Toppan Holdings (OTCPK:TOPPY), Dai Nippon Printing (OTCPK:DNPLY), and Photronics have been working at full capability. Some chip producers have been paying additional charges to photomask producers for expedited deliveries. The anticipated enhance in photomask costs ought to have a constructive impression on Photronics’ income in 2024. This must also assist to widen margins and assist the corporate obtain analyst consensus expectations of 13% EPS progress for FY24.

Photronics additionally has excessive working leverage as a low-cost producer. This helped the corporate obtain an working margin of 28.4% for FY23. This was the best working margin within the firm’s historical past. This was a major enchancment over the working margin of 25.7% from FY22 and 14.3% from 2022. The anticipated enhance in photomask costs driving the corporate’s income might widen the working margin additional in FY24.

Photronics achieves robust profitability metrics to drive its earnings progress.

We are able to see from the chart above that Photronics outperforms the sector median on most of its profitability metrics apart from gross margin [GM]. Regardless of lagging the sector in GM, PLAB’s different margins equivalent to EBITDA margin and web revenue margin make up for it as the corporate considerably outperforms the sector median. These vast margins and PLAB’s robust double-digit return on fairness and return on complete capital helps to drive the corporate’s double-digit earnings progress.

Valuation

Photronics is buying and selling attractively at 12.5x anticipated EPS of $2.30 for FY24. That is considerably beneath the sector median ahead PE of 23x.

Photronics additionally trades beneath its rivals with a ahead EV/EBITDA of 4.5x. Toppan trades with a ahead EV/EBITDA of 7x, whereas Dai Nippon Printing trades with a ahead EV/EBITDA of 8. PLAB additionally trades considerably beneath the sector median ahead EV/EBITDA of 14.9x.

PLAB’s inventory has loads of room to maneuver greater from this engaging low valuation.

I additionally cross-checked PLAB’s valuation with a reduced money circulation evaluation. The parameters for the evaluation are included within the desk beneath:

The time interval for the long-term progress fee is 5 years. With the present value at $28.78 and a good worth value of $39.66 in response to the DCF evaluation, Photronics is displaying upside of 37.8%.

The DCF evaluation truthful value appears to be like affordable. The 37.8% potential upside for the inventory could be achieved by PLAB’s anticipated EPS progress of 13% plus PE a number of growth because of the low valuation. The goal value of $39.66 would enhance the PE to 17.2x anticipated EPS of $2.30 for FY24. That’s nonetheless decrease than the sector median ahead PE of 23x.

The inventory value made a major transfer greater after the corporate’s fiscal This fall 2023 earnings report. Nonetheless, the value has been pulling again over the previous two weeks. The MACD reveals the change in pattern from bullish to bearish because the blue MACD line crossed beneath the purple sign line. The RSI confirms the change in pattern because it fell from an overbought situation. This appears to be like like revenue taking after the quick run-up in value.

Because the firm did not report any adverse information, I would not anticipate the value to drop a lot additional. I’d guess that the value would possibly drop to about $26 to $27 and switch the highs from July into assist. That will even be about midway down the flag pole of this latest bull flag formation after the final earnings report. I’ve noticed that a lot of these bull flag formations are inclined to cease dropping across the mid-point of the flag pole.

Stability Sheet/Money Move

The steadiness sheet appears to be like robust as Photronics has $499 million in complete money & equivalents with solely $18 million in long-term debt. The corporate additionally has a class of ‘different liabilities’ of $47 million on the steadiness sheet. Even the mixture of long-term debt plus different liabilities of $65 million continues to be considerably decrease than PLAB’s complete money.

The steadiness sheet additionally reveals PLAB with 4.2x extra present property than present liabilities and 6x extra complete property than complete liabilities for complete fairness of $1.3 billion. It’s noteworthy that PLAB has $561 million in retained earnings. Having considerably extra property than liabilities, more money than debt, and a excessive quantity of retained earnings demonstrates that PLAB has monetary stability and is in a terrific place for continued progress.

The corporate had $302 million in working money circulation for FY23. This was a ten% enhance over the working money circulation from FY22 and 2x greater than FY21. PLAB spent $131 million on CapEx and repaid $18.4 million in long-term debt. Solely $1.2 million value of widespread inventory was issued in FY23. The corporate was left with $122.8 million in unlevered free money circulation. PLAB’s robust money circulation additional demonstrates the corporate’s robust monetary place and its capability to develop going ahead.

Dangers for the Firm

The semiconductor business traditionally has been considerably cyclical. The business has giant spikes and dips which might create intervals of decrease income and earnings through the dips.

PLAB depends on a restricted variety of giant prospects. The corporate’s 5 largest prospects comprised 51% of PLAB’s income in FY23. The lack of enterprise from a number of of those prospects can have a major adverse impression on the corporate’s income.

Backside Line Outlook for Photronics

Photronics appears to be like nice from a valuation and progress standpoint. The inventory’s low valuation leaves loads of room for PE a number of growth whereas the corporate grows earnings at a double-digit tempo. The DCF evaluation above reveals about 38% upside for the inventory, which can be supported by the low valuation and powerful anticipated earnings progress.

The truth that Photronics is working at full capability creates the likelihood for growth when it comes to a brand new manufacturing facility. Within the meantime, PLAB is poised to profit from pricing power in 2024 because of the scarcity of photomasks available in the market.

Understand that the inventory has been pulling again just lately. New buyers could wish to scale in to the inventory or anticipate a affirmation of a continuation of the uptrend earlier than leaping in.

Editor’s Be aware: This text discusses a number of securities that don’t commerce on a significant U.S. change. Please pay attention to the dangers related to these shares.