Alpha And Omega Semiconductor: Speculative Shot At This Level Despite Risk (NASDAQ:AOSL)

Alpha and Omega Semiconductor (NASDAQ:AOSL), a supplier of power semiconductors, has fallen below a price level that had provided support to the stock for about a whole year. The stock bounced each time whenever it reached this level, but that is not what happened this week. The price action is bearish for several reasons, but long AOSL may still be worth taking into consideration as a speculative, yet calculated play. Why will be covered next.

Why betting on AOSL is risky at this time

A previous article from last January rated AOSL a hold. The article did so even though the stock was in the midst of a strong rally for several reasons. For starters, a bellwether for the analog industry had made a number of less than encouraging statements about the strength of the analog market, which did not bode well for AOSL, especially not with an earnings report coming up. All this and more was reason for the article to conclude there was a need for caution.

This proved to be warranted because the stock has lost more than a quarter of its value since then, which included a double-digit drop after the February report. The Q2 FY2024 report actually beat consensus earnings estimates of $0.15 by a comfortable $0.09, but this was more than offset by quarterly guidance that came in significantly weaker than expected. The guidance in effect corroborated much of what the industry bellwether had said earlier.

The chart above shows how the stock has trended lower with lower lows and lower highs in recent weeks, a bearish pattern. This culminated in the stock closing at $19.55 on April 19 after falling $0.47 or 2.35%, which means AOSL has lost 25% YTD. It also means AOSL has underperformed against most semis. The iShares PHLX Semiconductor ETF (SOXX), for instance, has gained 3.3% YTD in comparison.

With the recent decline, the stock punched through the lower end of the $20-22 price region, which is a region where the stock was able to find support several times before. This includes the May 2023 low of $20.64, the November 2023 low of $20.03 and the March 2024 low of $20.36 in the last 12 months as shown in the chart.

On each of these occasions, the stock proceeded to turn north after bottoming in the $20-22 region. This repeated bottoming in the same price region can be attributed to buyers stepping in at this price level, very likely for a reason. Recall how the stock fell from a high of $69.99 in March 2022 to a low of $20.03 in November 2023. This decline was preceded by a move upwards from a low of $5.82 in March 2020 to a high of $69.99 in March 2022.

The 76.4% Fibonacci retracement of $5.82 to $69.99 is $20.96, which is within the $20-22 region. This could help explain why buyers seem to step in to bid up the stock price whenever the stock reached this region, which then pushes the stock upwards. Speculators might have bet that this would happen again. On the other hand, each time stock got to support, the resulting bounce became less and less pronounced as shown in the previous chart, a possible sign support was wavering with fewer buyers stepping in.

This seems to what happened this week with the number of buyers willing to step in exhausted after a year. On the other hand, it’s still possible for the stock to recover. For a breakdown to truly count, the stock needs to spend several days below support, which has yet to happen. The stock is also close to oversold conditions, which may foster a rebound. Still, long AOSL is clearly a risky bet at this time.

Why placing bets on AOSL could be worth it even with the bears in the driver seat

The stock has fallen by so much in a short amount of time and it is likely due for a bounce. Furthermore, there are other arguments in favor of taking a shot at long AOSL. For instance, AOSL has total assets of $1,176,346K, which includes $162.27M of cash and cash equivalents, and total liabilities of $281,788K, which includes $32.57M of long-term debt. This means AOSL has a book value of $894,558K or $894.56M, which converts to about $32.35 per share with the total number of outstanding shares at about 27.65M.

AOSL priced at $19.55 a share is thus available at far below book value with a price-to-book value of 0.6x. Some might argue AOSL is therefore undervalued as justification for long AOSL. Note that $19.55 a share implies a market cap of roughly $552.87M for AOSL, well below TTM sales of $640M, which means AOSL as a company is valued at 0.86 times sales.

Keep in mind there is some possible upside to the balance sheet. AOSL still retains a minority stake in the Joint Venture Company in China, which is valued at $356.14M as an equity method investment. This stake could increase in value in a sale or an IPO of the JVC. Either one has the potential to give the stock price a significant boost.

Earnings are down at AOSL, but they are likely to recover soon enough

On the other hand, it is important to mention that companies can see their stock price fall below book value when there is a perception the company is under some sort of financial stress that could last for a while and which is likely to cause a reduction in book value. In the case of AOSL, AOSL has posted a GAAP loss of $17.15M or $0.63 per share on a TTM basis. Three of the last four quarters at AOSL ended in the red. So one can argue AOSL meets the precondition of a company under at least some financial stress.

The table below shows the most recent quarterly results. As mentioned earlier, AOSL beat estimates rather handily with non-GAAP EPS of $0.24, but it still posted a GAAP loss of $0.10 per share. The difference between GAAP and non-GAAP is mainly due to the latter’s exclusion of $0.29 of share-based compensation.

Both were much worse on a YoY basis. The decline in the bottom line can be mostly attributed to the decline in the top line. In Q2 FY2024, revenue declined by 12.4% YoY, which is the fifth consecutive YoY decline in quarterly revenue. AOSL is currently in a slump due to a drop in demand in the analog market.

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Source: AOSL Form 8-K

However, it was guidance that caused the stock to be sold off. Keep in mind that Q3 FY2024, which corresponds to Q1 2024, tends to be the weakest quarter as the quarter tends to experience a drop in demand due to seasonal factors. Yet even after accounting for seasonality guidance was weaker than expected based on historical patterns, especially considering Q3 FY2024 was going up against a low base in Q3 FY2023.

Guidance calls for Q3 FY2024 revenue of $140-160M, an increase of 13.1% YoY at the midpoint, but also almost $10M below expectations. The drop in margin is also more than expected even with seasonality. Using these guidelines, AOSL is estimated to post a non-GAAP loss of $0.15 and a GAAP loss three times as much when AOSL releases its next earnings report, which is scheduled to happen on May 7.

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Source: AOSL Form 8-K

Why AOSL may be on the verge of an upturn

Still, Q3 FY2024 is on track to be the first YoY increase in quarterly revenue after five consecutive quarterly declines, a positive sign. In addition, there is reason to believe this improvement could continue, certainly in the next two quarters, if only because of seasonality. Seasonality is a headwind in Q3 FY2024, but this changes in the fourth quarter of the fiscal and especially the first quarter of the fiscal, which tends to be the strongest. Comps will also be a tailwind due to the recent downturn which led to a drop in the numbers in recent quarters.

If seasonality holds, earnings are set to improve in at least the next six months and this could power a turnaround in the stock. AOSL is expected to report a loss when it reports next, but the next guidance should include a major improvement and AOSL could be back in the black by Q1 FY2025, if not Q4 FY2024.

Keep in mind AOSL itself expects the numbers to get better. From the Q2 FY2024 earnings call:

“Looking forward, we expect stabilization across most of our business lines notwithstanding normal seasonality. While near-term visibility is limited, we remain cautiously optimistic about a broader market rebound in the second half of calendar 2024.”

Source: AOSL earnings call

Quarterly results have suffered from excess inventories, but inventories have been reduced after five quarters of reduced shipments. End-market demand is still a question mark, but there are many industry sources calling for improvement in H2 2024. Most industry forecasts therefore call for the analog market to grow in 2024, even though the market might be off to a slow start.

For instance, WSTS predicts the analog market will grow by 3.7% YoY to $84B in 2024. In comparison, the analog market shrank by 8.9% YoY in 2023. This does not guarantee AOSL will improve as well, but it should help AOSL after spending the last five quarters dealing with weak demand.

Investor takeaways

Long AOSL has been a losing proposition for some time, especially lately, which makes it difficult to argue in favor of it. The stock has been weak pretty much all year, especially after the last earnings report saw guidance come in weaker than expected. The charts are leaning bearish with lower lows and lower highs for the stock. The stock has fallen below a key support level that held for about a year.

AOSL has seen sales shrink for five consecutive quarters due to a slump in demand. Semiconductor stocks have struggled recently, along with the stock market in general, due to various reasons, including where interest rates are heading and geopolitical tensions, especially in the Middle East. Getting into stocks at this time comes with elevated levels of risk due to the possibility of a stock market selloff.

Nevertheless, there is reason to be optimistic despite the prevailing headwinds. As pointed out earlier, seasonality was partially to blame for the weak results in the last report, but seasonality is set to turn from a headwind into a tailwind in the next few quarters. The next guidance in May should be much better than the last one.

In fact, the quarterly numbers are likely to get better in the next two reports, if not longer, due to a combination of seasonality, favorable comps and an easing in the inventory glut. End-market demand is more of an unknown, but the general belief is that it will be better in H2 2024 than H1 2024. In other words, AOSL might be on the verge of an upturn.

Furthermore, AOSL comes at a low valuation by trading well below book value. A stock price of $19.55 or a market cap of $553M means AOSL is available far below its book value of $895M or $32.35 per share. True, AOSL is likely to end FY2024 with an estimated GAAP net loss of no more than $20M. In terms of non-GAAP, AOSL should be in the black with an estimated profit of around $15M. In comparison, FY2023 saw GAAP net income of $12.4M and non-GAAP net income of $55M.

Still, while losses will reduce book value, the predicted losses are not at such an extent that they warrant AOSL trading as much as $342M below its book value of $895M. AOSL would have to post far bigger losses than it has shown in recent quarters for book value to be reduced by hundreds of millions. Such losses do not appear to be forthcoming, especially not with quarterly earnings expected to get better soon for reasons mentioned earlier.

I am therefore bullish on AOSL due to the above. Still, it is possible the stock could go lower. If we assume support is lost or the stock market sells off due to geopolitical tensions as is currently the case, the stock could easily go lower. Dollar averaging is best when there is the possibility the stock price could go lower in the short term.

Anyone who decides to take a shot at AOSL has to be okay with the possibility the stock price could drop below the purchase price in the short term for a chance at a potential payoff at a later date. There is also the possibility AOSL sees a further drop in end-use demand, which could affect the trajectory of the anticipated recovery. Even so, AOSL would have to post huge losses to bring book value to where the stock price is currently at.

Simply put, AOSL is valued far below book value at a time when quarterly earnings are likely to get better. Long AOSL is admittedly not a bet without risk, especially not with everything going on in the world, and AOSL has work to do, especially in terms of growth and earnings, but the combination of trading far below book value and an expected upturn in quarterly earnings in at least the next two quarters makes betting on the stock turning north a bet worth taking.