Camtek: Potential Threat From Emerging China Chip Tool Market

Camtek (NASDAQ:CAMT) is an Israeli company that designs and manufactures high-end inspection and measurement equipment for semiconductor businesses. As such, 84% of its revenues as of FY 2023 have come from China, Taiwan, and South Korea, three countries where semiconductor productions are concentrated.

CAMT went public in 2000 at $6 per share. The stock pretty much traded sideways only until 2017, when it started to consistently break higher highs, which continues today. As such, despite having delivered an all-time return of over 1,144%, a large component to that return appears to come from only the last five years. CAMT’s 5-year return is over 625%, and it is currently up 10% YTD, trading around $75 per share today.

I give CAMT a neutral rating. My 1-year price target of $82.68 projects almost 11% upside. However, I believe the recent focus by the Chinese government to boost domestic chip-making equipment may present potential competition risk. CAMT today generates almost half of its revenue from semiconductor players in China. It would probably be wise to watch from the sidelines for now.

Financial Reviews

Fundamentals have been quite decent over the past five years. Revenue has overall seen rapid growth in the same period, despite experiencing a -1.7% decline YoY in FY 2023. Moreover, profit margin and operating cash flow (‘OCF’) generation have also been expanding significantly. In FY 2023, net margin was 25%, the same level as the prior year. OCF has consistently been on an uptrend and reached a record-high of $79 million in FY 2023.

The strong OCF trend has benefited liquidity. Cash levels have been steady above $350 million in the past two years. Partly, it was also helped by over $194 million raised from note issuance in FY 2022. Eventually, this resulted in the debt-to-equity ratio going above 0.6x then, though CAMT has done quite well to bring it down to 0.4x today. In FY 2023, liquidity saw a slight down tick due to the acquisition of FRT for over $100 million.

Catalyst

CAMT remains in a good position to capture secular growth opportunities in high-performance computing (‘HPC’), which is driven by the increasing adoption of AI and 5G. In the Q4 earnings call, the management mentioned the potential growth areas in high bandwidth memory (‘HBM’) and also chiplets. I believe there indeed are attractive opportunities in these areas.

As per its 20-F, CAMT has market-leading measuring technologies that will enable leading semiconductor manufacturers to perform 100% inspection and produce high-quality end products. The process could become more complex in the context of advanced packaging, a technique increasingly used to drive performance gains. Consequently, this should continue driving demand for CAMT’s offerings.

Advanced packaging continues to become more commonly preferred in the HBM segment within the semiconductor market. As the investments by many leading semiconductor developers into this space increase, so will the demand for CAMT, in my view. Most recently, SK Hynix, a leading semiconductor player, invested over $1 billion in advanced packaging technology to strengthen its position in the HBM segment.

I believe CAMT has also prepared itself well to boost its capability here. One of the most recent initiatives here would be the acquisition of FRT, which develops unique inspection and metrology technologies. So far, CAMT has also made decent progress in terms of customer acquisition. Just last month, CAMT announced that it received a $25 million order from a tier-1 HBM manufacturer.

Risk

While China remains a dominant market for CAMT, with sales in the region making up 47% of revenue as of FY 2023, there is also a major risk of getting disrupted by emerging well-funded local players looking to offer similar solutions to capture the opportunity in the growing chip industry in China.

Recently, the Chinese government has invested over $150 billion to grow its domestic chip market since 2014, and expect to raise another $27 billion to boost chip-making equipment industries, which could potentially cover inspection and metrology, CAMT’s core market:

The third phase will reportedly invest mainly in chip-making equipment—an area in which China has struggled to break its import reliance (particularly for advanced chips).

Source: Economist Intelligence Unit.

Valuation / Pricing

My target price for CAMT is driven by the following assumptions for the bull vs. bear scenarios of the FY 2024 projection:

1. Bull scenario (50% probability) assumptions – I expect revenue to grow 25% YoY to $395 million, in line with the market’s estimate. I assume forward P/S to expand slightly to remain around 12x, implying a share price appreciation to $96.

2. Bear scenario (50% probability) assumptions – CAMT to deliver FY 2024 revenue of $380 million, missing the low-end market’s estimate by $9 million, a 20% YoY growth. I assign CAMT a forward P/S of 9x, a contraction that projects correction to $69.

Consolidating all the information above into my model, I arrived at a FY 2024 weighted target price of $83 per share, projecting an almost 11% 1-year gain from the current price of $75. I would rate the stock neutral for now. Given the potential fresh threat from the state-sponsored initiative in China to boost domestic chip-making equipment markets, I feel that it is best to monitor the progress of the new $27 billion capital deployment in China before considering dipping in.

Conclusion

CAMT is a leading inspection and metrology equipment manufacturer for semiconductor industries. The rise of AI and 5G will increase the need for advanced packaging, effectively driving higher demand for CAMT’s solutions. However, almost half of CAMT’s revenues have come from semiconductor players in China, as of FY 2023. Given the recent increased focus towards growing the domestic chip-making equipment industries by the government in China, as demonstrated by the $27 billion capital raise to invest in the project, may present a future threat for CAMT. Despite the double-digit 1-year upside, I advise investors to watch from the sidelines for now.