Entegris (NASDAQ:ENTG), a supplier of materials and process solutions for the semiconductor industry, ended 2022 near the lows for the year, but it is off to a strong start in 2023. In doing so, the stock may have broken out of a downtrend. This happened even though ENTG has to contend with a range of outstanding issues, including an industry slowdown and a bloated balance sheet after the acquisition of CMC Materials. These issues have weighed on the stock, which contributed to ENTG losing more than half its value in 2022. However, ENTG will soon be due for its next earnings report, which could pour cold water on the rally. Why will be covered next.
Why ENTG may have broken through
The stock lost more than 50% in 2022, but ENTG has made great strides in 2023 towards recouping those losses with the stock up 29% YTD. The chart below shows how the stock has rallied in the new year after ending 2022 on a low note. Keep in mind that the entire semiconductor sector has rallied along with ENTG. The iShares PHLX Semiconductor ETF (SOXX), for instance, is up 22.4% YTD.
Note the descending trendline connecting all the highs in the chart. The stock has been stuck below this trendline for quite some time. That is until a couple of days ago with the stock having moved above the resistance imposed by the trendline. This suggests the trend has, or is, in the process of changing from a bearish stance towards something else.
Note also how the stock did not fall back below the trendline, despite losing 3.8% on Friday. The stock did touch the trendline, only to bounce to stay clear of it. This suggests that what used to be resistance may have become support, which could be the signal those in need of a good entry point were waiting for. This is likely to strengthen the conviction of those who believe the downtrend has been broken with the stock seemingly completing a backtest, provided the stock does not go lower.
Those who are bullish on ENTG are likely to be encouraged by this turn of events. It is also likely to sway the doubters out there that ENTG has turned a corner. More buyers could decide to step in given the recent price action, which could provide the fuel for the rally to continue.
Why the next earnings report from ENTG could play the spoiler
The stock appears to have broken through, but it’s possible the stock could reverse course once more. This could happen due to the release of its next earnings report on February 14. If the numbers and/or guidance are worse than expected, then that may just be the catalyst for a renewed slide in the stock.
Consensus estimates are currently looking for GAAP EPS of $0.41 and non-GAAP EPS of $0.79 on revenue of $954M. These estimates are higher than ENTG’s own guidance for Q4. Keep in mind that ENTG missed estimates for the top and the bottom line in the last report. Guidance also disappointed. Consensus estimates were expecting guidance to call for revenue of $1B and non-GAAP EPS of $1.04 in Q4, but actual guidance came in much lower as shown below. If that happens again, the stock is not likely to react well, especially with all the other question marks hanging over ENTG.
(GAAP) |
Q4 FY2022 (guidance) |
Q4 FY2021 |
YoY (midpoint) |
Sales |
$930-970M |
$635.2M |
49.56% |
Net income |
$42-50M |
$118.2M |
(61.08%) |
EPS |
$0.28-0.33 |
$0.87 |
(64.94%) |
(Non-GAAP) |
|||
Sales |
$930-970M |
$635.2M |
49.56% |
Net income |
$112-120M |
$131.8M |
(11.99%) |
EPS |
$0.75-0.80 |
$0.96 |
(19.27%) |
Source: ENTG Form 8-K
Keep in mind that Q4 FY2021 preceded the acquisition of CMC Materials, which is skewing the quarterly comparisons like the almost 50% YoY increase in revenue. Q4 guidance also incorporates the negative impact of trade restrictions on China to the tune of $40-50M. The table below shows how the quarterly numbers have changed with the addition of CMC Materials.
(GAAP) |
Q3 FY2022 |
Q2 FY2022 |
Q3 FY2021 |
QoQ |
YoY |
Sales |
$993.828M |
$692.489M |
$579.493M |
43.52% |
71.50% |
Gross margin |
37.4% |
44.8% |
45.6% |
(740bps) |
(1820bps) |
Operating margin |
1.5% |
22.8% |
24.0% |
(2130bps) |
(2250bps) |
Operating income |
$14.889M |
$157.970M |
$139.357M |
(90.57%) |
(89.32%) |
Net income (loss) |
($73.703M) |
$99.491M |
$117.461M |
– |
– |
EPS |
($0.50) |
$0.73 |
$0.86 |
– |
– |
(Non-GAAP) |
|||||
Sales |
$993.828M |
$692.489M |
$579.493M |
43.52% |
71.50% |
Gross margin |
43.6% |
44.8% |
45.6% |
(120bps) |
(200bps) |
Operating margin |
25.5% |
26.4% |
26.3% |
(90bps) |
(80bps) |
Operating income |
$253.207M |
$183.039M |
$152.696M |
38.33% |
65.82% |
Net income |
$127.770M |
$136.816M |
$125.383M |
(6.61%) |
1.90% |
EPS |
$0.85 |
$1.00 |
$0.92 |
(15.00%) |
(7.61%) |
Q2 FY2022 was the last quarter for ENTG as a standalone company. So while, for instance, Q3 revenue increased by 43.5% QoQ and 71.5% YoY, Q3 revenue actually declined by 2% QoQ and it increased by 14% YoY on a pro forma basis, which strips out the contributions from CMC Materials. The big difference in GAAP and non-GAAP net income in Q3 FY2022 can be attributed to expenses associated with the CMC acquisition, including transaction, contractual and integration costs.
Note that ENTG had to issue new shares to CMC shareholders, resulting in share dilution. The non-GAAP weighted average of shares outstanding, for instance, jumped to 149.67M in Q3 FY2022, up from 136.63M in Q2 FY2022. On the other hand, adjusted EBITDA rose to $298.4M in Q3 FY2022, up from $207.4M in Q2 FY2022 and $175.5M in Q3 FY2021.
Why the outlook from ENTG matters
Guidance did not extend beyond Q4 and management declined to give out any specific numbers regarding FY2023, although ENTG did acknowledge a downturn in the semiconductor industry. ENTG pointed out that the market downturn remains in a state of flux, which leaves a lot of room for things to move to the upside, but also the downside. From the Q3 earnings call:
“So obviously, there is growing evidence that we are headed into a downturn in 2023. But it’s too early for us to give a much quantification of the various industry drivers. I think at this point, the depth and the duration of the downturn remain very unclear. And I would make a similar statement when it comes to the permanent impact of the new export controlled restrictions. That situation remains dynamic.”
A transcript of the Q3 FY2023 earnings call can be found here.
However, the upcoming quarterly release could shake things up as it is almost certain to include updates to the outlook for FY2023. And if what other semis have reported in their forecasts, then it is likely to be to the downside. ENTG is after all dealing with a number of issues that need some clarification and any color from ENTG could go a long way towards determining the trajectory of the stock.
For instance, while it is generally agreed upon that FY2023 is likely to be a down year for ENTG, the impact of acquisitions excluded, there is some disagreement as to the extent of the decline. How much earnings are expected to decline could greatly influence valuations for ENTG and the stock by extension. The table below shows some of the multiples ENTG trades at.
ENTG |
|
Market cap |
$12.61B |
Enterprise value |
$17.76B |
Revenue (“ttm”) |
$2,971.2M |
EBITDA |
$782.5M |
Trailing GAAP P/E |
43.64 |
Forward GAAP P/E |
44.10 |
PEG ratio |
– |
P/S |
3.95 |
P/B |
4.04 |
EV/sales |
5.98 |
Trailing EV/EBITDA |
22.70 |
Forward EV/EBITDA |
17.93 |
Source: Seeking Alpha
In general, ENTG trades at higher valuations than most semis. For instance, ENTG trades at 44.1 times forward GAAP earnings with a trailing P/E of 43.6. This is much higher than most semis with the median for the sector at 24.9 and 25.2 respectively. The gap could get even wider if earnings shrink more than expected in the next 12 months. Unless of course, the stock price goes down to compensate for lower earnings.
Why the balance sheet could be an ongoing issue for ENTG
Note how ENTG’s enterprise value of $17.76B is much higher than its market cap of $12.61B because of all the debt ENTG carries on its balance sheet. Total debt stands at $6B, partially offset by $754M in cash and cash equivalents. Of that amount, about $5.3B in debt can be attributed to the acquisition of CMC. ENTG thus went from essentially free of debt to one that is heavily in debt.
ENTG has begun the process of reducing debt. For instance, ENTG will sell CMC’s PIM unit for $240M to pay off some of the debt. Still, if ENTG is to deleverage, earnings need to keep up, which may not be so easy if there is a severe downturn in the industry. Any comments regarding guidance or outlook from ENTG will be scrutinized for that reason.
If ENTG suggests the downturn is more severe at the upcoming earnings call, similar to what many other companies are projecting in their guidance, and the income statement is set to deteriorate, then that could trigger a selloff in the stock, especially with the current state of the balance sheet.
Investor takeaways
I am neutral on ENTG. ENTG has appreciated by almost 30% in about 5 weeks. The charts also suggest the stock has broken through a downtrend that has been in place for some time. While momentum followers may see that as justification for long ENTG, others could see it as a signal to take a step back as achieving those kinds of gains in that amount of time is highly unlikely to be sustainable. The stock is likely due for a pullback of some sorts.
The upcoming earnings report could be the catalyst. Expectations are way higher than what ENTG called for in its guidance, which looks like a tall order. ENTG fell way short the last time around. The next guidance could disappoint once again. ENTG is also likely to provide some insights as to FY2023, which will be eagerly anticipated given that ENTG has a lot of debt to service and it cannot afford to have earnings shrink by too much.
An argument can be made that ENTG is too highly valued given the highly leveraged state of the balance sheet and the high probability that the income statement will remain under pressure for some time, given that the semiconductor industry is currently faced with a downturn and declining demand by extension. Companies are likely to postpone, if not cancel altogether, some of the fabs they are working on, given how the semiconductor market has deteriorated, which does not bode well for ENTG.
Bottom line, while some may want to roll the dice and stick with long ENTG as it has worked very well thus far in 2023, others are likely to decide that there are good reasons to keep their distance. Nothing is set in stone, but ENTG is more likely to disappoint than surprise when it reports next. This being the case, standing on the sidelines looks best.
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