Entegris: Possibly Mistimed CMC Materials Acquisition (ENTG)

Entegris (NASDAQ:ENTG) is in a tricky spot. The company is still growing at a solid pace and market demand remains firm at the moment, but there are signs that may not hold true for too much longer. At the same time, ENTG has made a promising bet on the future with the acquisition of CMC Materials or CCMP, but it needed to leverage itself at what could turn out to be a bad time. Why will be covered next.

ENTG is still doing fine

At the moment, ENTG can still count on a healthy market as shown by its most recent quarterly report. Q2 revenue increased by 21.2% YoY to $692M. GAAP EPS increased by 12.3% YoY to $0.73 and non-GAAP EPS increased by 17.7% YoY to $1.00. Adjusted EBITDA was $207.4M in Q2 FY2022, $206.2M in Q1 FY2022 and $174.2M in Q2 FY2021. The table below shows the numbers for Q2 FY2022.

Note how the bottom line did not improve as much as the top line with margins lower than before. In fact, ENTG missed consensus estimates and its own guidance of $1.02-1.07 for non-GAAP EPS. It’s therefore worth mentioning that fluctuations in foreign exchange rates lowered non-GAAP EPS by $0.15. Sales and gross margin could have been higher if not for forex.

(GAAP)	Q2 FY2022	Q1 FY2022	Q2 FY2021	QoQ	YoY
Sales	$692.489M	$649.646M	$571.352M	6.59%	21.20%
Gross margin	44.8%	47.7%	46.4%	(290bps)	(160bps)
Operating margin	22.8%	25.1%	24.3%	(230bps)	(150bps)
Operating income	$157.970M	$163.346M	$138.889M	(3.29%)	13.74%
Net income	$99.491M	$125.705M	$88.770M	(20.85%)	12.08%
EPS	$0.73	$0.92	$0.65	(20.65%)	12.31%
(Non-GAAP)
Sales	$692.489M	$649.646M	$571.352M	6.59%	21.20%
Gross margin	44.8%	47.7%	46.4%	(290bps)	(160bps)
Operating margin	26.4%	28.1%	26.5%	(170bps)	(10bps)
Operating income	$183.039M	$182.251M	$151.603M	0.43%	20.74%
Net income	$136.816M	$145.133M	$116.711M	(5.73%)	17.23%
EPS	$1.00	$1.06	$0.85	(5.66%)	17.65%

Click to enlarge

Source: Entegris Form 8-K

ENTG recently completed the acquisition of CMC Materials or CCMP, which means the Q2 report is the last one for ENTG as a standalone company. As a consequence, guidance issued was less detailed than usual with no EPS given. Still, guidance calls for Q3 sales of $1.00-1.04B with contributions from both ENTG and CCMP included.

As a reference, sales in Q3 FY2021 stood at $579.5M before the CCMP acquisition. Furthermore, ENTG sees FY2022 sales ending up at $4B+, an increase of over 16% YoY on a pro forma basis. From the Q2 earnings call:

“Now transitioning to our outlook for the full year, the legacy Entegris business is tracking in line with our previous expectations for 2022, driven by very strong demand for our products and solutions and continued excellent execution by our supply chain teams. We also expect the positive momentum of the legacy CMC Materials business will continue into the second half of the calendar year. Putting it all together on a pro forma basis, excluding CMC’s wood treatment business, we expect revenue for the combined company to exceed $4 billion and grow in excess of 16% in calendar 2022. And we expect pro forma EBITDA of the combined company to be approximately 30% of revenue in calendar 2022.”

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

Management remains upbeat about the state of the market as it relates to demand.

“I would say, the chip demand and CapEx activity is expected to remain pretty strong through 2022. And certainly, the demand for our products is expected to remain at record levels because of the growing importance of what we do for our customers. So that’s the headline. And the additional data point I will share with you is that today, at Entegris, we still have an unconstrained demand that is higher than our guidance. So even if the industry slows down a little bit, we should be able to carry our momentum through the balance of the year.”

All in all, ENTG is in good shape, at least as this point in time.

Why the CCMP acquisition may have come at a bad time

ENTG needed $5.7B to acquire CCMP with $3.8B in cash. In order to finance the deal, ENTG needed to take on debt through several transactions. In total, ENTG added $5.3B in debt, bringing gross debt up to $6.1B, giving ENTG a gross leverage of 5.1x. While the Q2 report precedes the closing of the CCMP acquisition, some changes can already be seen in the balance sheet.

For instance, cash and equivalent jumped to $2,743.2M in Q2 FY2022, up from $352.7M in Q1 FY2022 and $401M in Q2 FY2021, as a result of $2,527.3M from debt proceeds. At the same time, long-term debt jumped to $3,408.8M in Q2 FY2022, up from $937.3M in Q1 FY2022 and $936.4M in Q2 FY2021.

The balance sheet has deteriorated with ENTG needing to take on a lot of debt. ENTG will spend years paying down the debt and the interest on that debt. This may not seem like too much of a problem at the moment with earnings on the rise, but that could change in the future. The semiconductor market is still growing, but it has slowed down considerably.

For instance, a recent report from Gartner predicts global semiconductor revenue will grow by 7.4% YoY in 2022, down from the 13.6% expected earlier in the year. In comparison, semiconductor revenue grew by 26.3% YoY in 2021. Furthermore, revenue is projected to shrink by 2.5% YoY in 2023. While some market segments are doing okay, the market for semiconductors in general is slowing down, especially when it comes to smartphones and PCs.

Such a development could cut both ways for ENTG as essentially a supplier of materials to be used in the manufacture of semiconductors. On the one hand, ENTG believes it stands to benefit from greater wafer content as the industry moves towards more advanced nodes. On the other hand, not all applications require leading-edge nodes. For instance, smartphones and PCs tend to be among the first adopters of leading-edge nodes and both are seeing slowing demand.

Companies like Nvidia (NVDA) and Qualcomm (QCOM) are some of the leading adopters of leading-edge nodes and they have all issued weak forecasts recently. If the industry slows down, earnings at ENTG could come under pressure. Slowing PC and smartphone demand could result in reduced investment in leading-edge nodes, which could negatively impact ENTG.

It would also come at a time when ENTG has levered itself by taking on a substantial amount of debt to acquire CCMP. So in that sense, the recent acquisition could backfire on ENTG. ENTG acquired CCMP as it is seen as beneficial and while that may turn out to be true in the long run, it could also cause problems in the medium term, depending on the extent of the downturn in the semiconductor industry.

In addition, it’s worth mentioning that a downturn could also come at a bad time in terms of where valuations are. ENTG may not trade at lofty valuations, but they are on the high side. For instance, the stock is valued at 7.4 times book value, which is more than double the sector median at 3.3x. The table below shows the multiples for ENTG. Note that the multiples have yet to include contributions from the recent CCMP acquisition.

	ENTG
Market cap	$15.57B
Enterprise value	$18.79B
Revenue (“ttm”)	$2,556.8M
EBITDA	$771.0M
Trailing P/E	30.93
Forward P/E	28.43
PEG ratio	0.85
P/S	5.55
P/B	7.43
EV/sales	7.35
Trailing EV/EBITDA	24.37
Forward EV/EBITDA	17.86

Click to enlarge

Source: Seeking Alpha

The stock is in a holding pattern

The stock has been going sideways more or less for the last three months as shown below. The stock is off the lows for the year, but it is still down 24% YTD and it seems to be struggling for direction. The charts may be in the process of forming a symmetrical triangle, a consolidation pattern. The stock is likely to continue to move sideways until the stock breaks through either the lower or the upper trendline.

A break higher or a break lower are both possible, but the latter could be the more likely outcome. One could argue the stock is in a downtrend that started in late 2021. The stock has moved off the lows, but it has yet to show that the trend is not down. If the trend is indeed down as has been the case for the better part of a whole year, then a move lower may just be in store.

Investor takeaways

CCMP complements ENTG and could turn out to be a good acquisition in the long run. However, in the more immediate future, the CCMP acquisition may have come at an inopportune time. ENTG took on a lot of debt to finance the acquisition which needs to be paid back. It may not be a problem at this time with earnings still strong, but that could change down the road.

Earnings are still growing at ENTG and demand still appears to be in good shape. But there are clear signs the semiconductor industry is getting weaker after several years of expansion. The semiconductor market is still growing in 2022, but it could start to contract as soon as next year. ENTG could find itself in a position where earnings are under pressure due to changes in the semiconductor market, just when it needs to begin servicing the billions of debt it took on at what may have been an inopportune time.

I am neutral on ENTG as stated in a previous article. Long ENTG is not without merit. ENTG still has good prospects in the long run and the quarterly numbers look fine. ENTG should be fine for the rest of FY2022 with sales likely to end up at $4B+ and EBITDA margins of at least 30%. On the other hand, what happens beyond 2022 is less clear.

Clouds seem to be gathering on the horizon with the market for semiconductors slowing down. Multiples are on the high side for a semiconductor name. ENTG could be in the early innings of a downturn that could result in earnings going down. ENTG needed to leverage itself, but the timing may not have come at the best of times. Add all this together and it becomes clearer as to why long ENTG is a more iffy proposition than it appears at first.