Now’s the Time to Buy Axcelis (NASDAQ:ACLS) Stock

Introduction

I rarely give companies a ‘Sell’ rating. I use this rating as a short sell, and given the costs of short selling, I think they either need to learn non-public information that indicates fraud or structural weakness, or there must be a big catalyst in the short term, which is not yet rated.

In September 2023, I was convinced that Axcelis Technologies (NASDAQ: ACLS) would struggle, and this has yet to be assessed. So I gave it a “Sell” rating. The stock is down 29%, while the S&P 500 is up 32% since that analysis. Although I changed my rating to “Hold” due to the valuation, the company continued to disappoint its investors.

It’s a semiconductor company that doesn’t benefit from the rise of artificial intelligence. There are no immediate catalysts for the up. Exposure to electric and hybrid vehicles and consumer electronics are not engaging when consumers are trying to trade up and save more. A recession is still likely. In this environment, I find no reason to invest in Axcelis Technologies.

I reiterate my “Hold” rating with this quarterly follow-up article.

Business description

I don’t like writing articles without proper business description. However, I’ve already explained Axcelis’ business a few times, so this will be short. Please see one of my older articles for a more detailed description.

There are many processes required to manufacture semiconductors, which enable various electronic products, from personal electronics to automobiles and sensors. A major process is design and engineering, which Nvidia (NVDA) does. The company does not manufacture these chips itself, but outsources them to specialized manufacturing companies, called foundries.

The foundry business is capital intensive. Companies need a lot of equipment and services to produce the final product. Axcelis is one of the main suppliers of these foundries, offering ion implementation and other processing equipment. These products help to modify the electrical properties of semiconductors.

Developing these complex technologies and establishing relationships with large foundries takes time. Once established, it is expensive for foundries to look for alternative products. That’s why existing players like Axcelis and Applied Materials ( AMAT ) enjoy high barriers to entry.

Recent developments and stock performance

My first article about Axcelis was published on September 26, 2023. It’s been almost a year. During this period, Axcelis shares significantly outperformed the broader market. The stock fell 29%, while the S&P 500 rose 32%.

This underperformance is due to fundamental underperformance, which we discuss further in the outlook section.

Although the company beat EPS and revenue estimates in Q2 2024, a quick look at the financials shows that stock turnover has declined over the past two quarters and revenue is significantly lower than in 2023. Management guidance for Q3 2024 is not promising. either, implying only a slight improvement over Q2 2024.

Compared to when we published the next quarter last year, revenue expectations have fallen considerably. In the chart below, the dark blue bars represent earnings expectations now, while the light orange bars represent earnings expectations as of May 31.

This change in earnings expectations is the main reason behind the recent share price decline. The reason behind these changing expectations can be better understood by assessing the strength of the end market in the next section.

Prospects for the near future

My last article outlined the three main growth areas for Axcelis Technologies: electrification, communications and artificial intelligence. This article will combine this analysis with the market segments shared during the most recent investor presentation.

In Q2 2024, 63% of sales were generated in the “Power” segment. The key driver for this end market is the demand for electric and hybrid vehicles. This is the electrification story we discussed last quarter. Not only has vehicle sales growth stagnated, but the transition to electric vehicles appears to have lost steam. Tesla is still struggling with its cheaper Chinese competitors and seems to be losing, especially in Europe. As an industry pioneer, this can affect the capital the company allocates to research and development, harming innovation. The Fed’s rate cut in September could be a catalyst for higher vehicle sales, but I think it will take longer for rates to come down significantly.

Management says it is closely monitoring the Power for AI data center market. However, as quarterly sales show, the company has not been able to benefit from them to the extent that others have. Axcelis seems to have failed to become a major AI technology provider so far.

The second largest end market was “General Mature” with 30% of total system revenue. This is another end market that is struggling due to consumer exposure. I have discussed the weakness of the American consumer in some of my recent articles. According to studies, the average US consumer has spent their savings caused by the pandemic, has a lower real wage compared to two years ago and is trading down to save more money. This includes postponing purchases and buying cheaper alternatives. In the case of consumer electronics, bearish trading mostly means putting off purchases if consumers don’t have to.

In such an environment, demand for consumer electronics, and therefore the parts that go into them, declines. This affects the General Mature part of the Axcelis business. Therefore, the company is waiting for the recovery of the macroeconomic environment and customer spending. I think it is difficult to bet on this recovery in the short term. Recessions often occur right after the Fed starts cutting rates, and we’re currently in that phase.

Although it was insignificant compared to the top two end markets, “Image Sensor” contributed 5% of the total revenues. Management says demand is robust in China but subdued across the board due to consumer weakness. As discussed above, I don’t think now is the best time to bet on this ultimate market exposure.

In addition, the company sells memory chips and advanced logic, which contributed 12% of sales in fiscal 2023. However, in Q2 2024, advanced logic contributed 2% of total revenue, and the memory business did not generated no income. This is remarkable to me and shows how hard Axcelis has worked to become a vendor in the AI ​​space. Management expects a rebound in Q4 in the memory space, but with continued investment in data centers and low but existing consumer electronics production, the company should have generated some gains from the memory business. This result leads me to believe that this business has become very unsuccessful and I do not want to predict when sales will recover. It would be highly speculative if I tried to predict.

The market segment delivered system revenue below from fiscal 2023 shows how much the sales mix has changed since then. Memory dropped from 10% to 0%, while advanced logic was relatively flat.

ASSESSMENT

As discussed, long-term revenue expectations have fallen, as have free cash flow expectations. My initial price target on the stock was $107 and I updated my price target to $113 last quarter. This price target will be affected by downward expectations.

My target price in my initial short thesis was $107. In the next article, I maintained this target but closed the short position with a hold thesis as the macro environment appeared to be improving. The stock actually fell below that price target and has now recovered slightly to $113 at the time of writing. The target price has changed only slightly since the last analysis.

Updating my previous model with new expectations, I now expect the company to generate adjusted free cash flow of $231 million in 2024, unchanged from last quarter, and $355 million in 2028, which is lower than what we used last quarter. I use a terminal growth rate of 3% and calculate the WACC using a long-term risk-free rate of 2%, a market risk premium of 5.7%, and the stock’s 5-year beta.

To remind you, in my calculations I separate cash and short-term investments into operations and excess. Operating cash is what the company uses for day-to-day operations. The rest is excess money. This excess cash can be claimed by the shareholders, but not the operating cash, because the business needs it.

Using these numbers and methods, we find an equity value of $3.45 billion, implying a stock price target of $105.33. That’s a 3.7% downside to the stock’s current price at the time of writing.

Conclusion

I appreciate that companies have a long-term opportunity, but there needs to be at least a strong near-term catalyst for a company to be a “Buy” for me. In the case of Axcelis, the only short-term catalysts that exist are to the downside.

Weaker consumers are hurting the business, while Axcelis continues to show that it has failed to capture a share of the huge AI market. Demand for end markets, including vehicles and consumer electronics, is declining, and Axcelis is not signaling a quick recovery.

With a share price that appears to be fairly valued, I reiterate my ‘Hold’ rating.