Nova May Be At The Right Place For A Speculative Play (NASDAQ:NVMI)

The last 12 months have been pretty good for Nova (NASDAQ:NVMI), a supplier of metrology and process control tools for the semiconductor market, at least as far as the stock goes. The stock bottomed in October of last year, only to nearly double in value after the stock hit a new 2023 high in late August. This rally is even more noteworthy considering how NVMI is dealing with several headwinds, including declining earnings. However, the stock has retreated in recent weeks and it may now be at a crucial junction. Why will be covered next.

NVMI is back to familiar territory

A previous article from last July rated NVMI a hold for several reasons, including the fact that the stock was close to a key support level and at risk of falling below it unless the stock stopped making repeated attempts to break through. As it turned out, support held and the stock reversed course, paving the way for the stock to hit a new 2023 high in August as shown in the chart below.

The stock hit a 2023 and 52-weeks high of $131.51 on August 30, adding to the rally that started in October 2022 when the stock hit bottom at $67.40. This represents a gain of 91.5%. However, the stock has retreated after the recent high and it is now back to the $107.50-112.50 region. This happens to be a region where the stock has encountered support and resistance on a number of instances in the last two years, including last June/July.

Why it may be a good time to be long NVMI, at least for the short term

The stock has lost 16% in recent weeks since the August high, even though the stock is still up 35.3% YTD. While the stock is technically not yet oversold, the stock may be due for at least a bounce after sliding for the last several weeks. Such a bounce is even more likely now that it has reached the $107-50-112.50 region, which is where the stock halted its decline as recently as July to go higher.

Support could come into play once more. It happened before, so it could very well happen again. Furthermore, the overall trend for the last 12 months has been up for NVMI. This argues against a continued decline in the stock. True, trends do not last forever, but as long as the trend has not been broken, the stock is most likely heading in the direction of the prevailing trend, which is up.

In addition, an argument can be made that NMVI is now trading below fair value. For instance, non-GAAP EPS grew at a CAGR of 27.8% in FY2018-2022. If we then assume EPS will grow by 27.8% per year on average in FY2022-2026 or something close to that number, then fair value for NVMI would be around $133 with TTM EPS of $4.81. This is well above the current price of $110.50. It might also explain why the stock peaked at $131.51 last August, being close to fair value of $133 or so.

Is the rally at risk of stalling or worse?

The stock has rallied higher for almost a whole year. That’s pretty impressive, but what’s even more remarkable is that the rally kept going even though NVMI faces various headwinds. This includes an industry downturn, which has led to weaker demand for semiconductor manufacturing equipment and in turn to weaker earnings at NVMI.

Revenue, for instance, peaked in Q4 FY2022 after the 11^th consecutive sequential increase in quarterly revenue, but the numbers have gone down since then. In the most recent report, revenue declined by 7.2% QoQ and 13.4% YoY to $122.7M. GAAP EPS was $0.94 and non-GAAP EPS was $1.06, both down QoQ and YoY. The table below shows how the numbers have declined recently.

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Source: NVMI Q2 FY2023 report

On the other hand, the numbers are expected to improve in Q3, albeit slightly. Guidance calls for Q3 FY2023 revenue of $119-126M, which is down YoY, but up QoQ at the midpoint. The forecast calls for GAAP EPS of $0.83-0.94 and non-GAAP EPS of $1.02-1.13. The latter is down YoY, but also up QoQ at the midpoint. It’s possible NVMI is past the trough in the downturn.

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Furthermore, the general expectation is that demand for semiconductor manufacturing equipment will return to growth in 2024 after shrinking in 2023. For instance, a recent report from SEMI predicts sales will grow by 14.4% YoY to $100B in 2024, a year after shrinking by 18.6% YoY to $87.4B in 2023. The year 2024 is thus expected to be a year of growth for NVMI.

Keep in mind that forward projections are always subject to revisions. There are some signs chipmakers like TSMC (TSM) are delaying deliveries of fab equipment due to worries about chip demand. It’s possible the equipment market might not expand as much as predicted if companies start to have second thoughts about expanding and need less equipment as a result. Note that TSM is a key customer of NVMI.

Still, a return to growth could help lower multiples, which in the case of NVMI may be necessary. The table below shows some of the more commonly used multiples for NVMI in comparison to KLA Corp (KLAC), the leader in the market for metrology and process control tools. In general, NVMI tends to trade at higher multiples than KLAC. Some might prefer to go with KLAC than NVMI for this reason.

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Source: SeekingAlpha

Could there be a surprise in the offering for NVMI?

A major factor why NVMI has seen strong growth in recent years is because of growth in China. For instance, according to the most recent annual report, China accounted for 28% of total sales in FY2022, up from 19% in FY2020. China has outperformed for NVMI and this continued in the latest quarter with China sales reaching a third of total sales.

This happened even though NVMI is subject to trade restrictions imposed by the U.S. government, which limit the kind of equipment that can be supplied to certain companies in China, especially at the leading edge. NVMI has been able to offset the loss of sales due to these restrictions by focusing on equipment for mature or trailing edge process nodes in the Chinese market.

However, there are calls in the U.S. Congress to expand the restrictions on the kind of equipment that can be sold to China. The feeling is that the current restrictions do not go far enough since China has progressed faster than expected. If more export controls are imposed, NVMI stands to be affected. Not only that, the impact could be rather large due to how much NVMI depends on China for sales.

Investor takeaways

An argument can be made that NVMI is a buy with the stock where it is at the moment. The stock seems to be close to support, which just a few months earlier was able to put a halt to the decline in the stock. This could happen again after the recent slide in the past few weeks, especially in light of the prevailing trend. If the stock bounces in the near term for these reasons, it could make its way back to the August high since that would bring it closer to fair value than it is right now.

Nevertheless, I am neutral on NVMI. There are a number of question marks hanging over NVMI. While equipment demand is down, it is widely expected to grow again in 2024. This has negated the fallout of declining earnings in recent quarters due to the downturn with the market looking forward to better times. On the other hand, semiconductor demand has been weaker than expected and while most chipmakers are sticking with their expansion plans, there are questions as to how long this can continue if the semiconductor market does not return to growth.

The recent reports of TSM seeking to postpone the delivery of equipment may be the start of chipmakers scaling back their expansion plans to account for semiconductor demand that has not been where it was anticipated to be. This could be very relevant to NVMI since the stock has seen its multiples expand based on the assumption of a return to strong growth in the near future. Granted, these concerns have not held the stock back, which has rallied for almost a year, but that does not mean they are to be summarily dismissed.

A possible wildcard that might shake things up for NVMI may be the possibility of increased export controls on China, a market that has greatly lifted results at NVMI recently. In the worst case, NVMI may have to face an industry downturn that lasts longer than currently expected. If NVMI has to deal with vastly expanded export controls on top of already soft demand, then it becomes clear why NVMI may be at risk of being repriced to account for different circumstances.

Bottom line, the trend is your friend as they say and it is hard to fault someone for sticking with something that has worked for almost a whole year. The stock seems to be close to support, which makes for a good entry point if anyone is looking to get in after the recent slide in the stock. Still, there are risks out there that could spoil the party. If the risks are acceptable, then long NVMI is worth pursuing. If not, then it may be time to consider locking in gains after the year-long rally as no rally lasts forever.