AMS.ZU - semiconductor growth company that can be bought cheap

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Avatar for JohnyTempus
2 years ago

In this article, I want to present you another investment idea, another stock pick that could bring you good returns.
You can check my previous article as well on MAC (Macerich) - you can potentially say, that you are a bit late on that trade, but still actionable, though the stock increase in price by around 24% since that post, though it still has room to grow as per the price targets in the article.

Nevertheless, back to AMS. AMS is a semiconductor(computer chips) manufacturer based in Europe, but with offices in US, Europe and Asia. It manufacturers semiconductors linked to different type of sensors (used in phones for face recognition, in cars to detect other cars, obstacles, in medical sphere, etc.) If yyou want to know more, visit:Products | ams

If you follow the financial news you most probably already heard about the semiconductor shortage in the world. If in short - we need so many chips for phones, computers and now electric cars, that there is not enough capacity in the world to meet that demand. Car manufacturers were hit HARD by this and for example Ford had its production sites closed due to shortage and it had a big impact on their earnings for Q1 2021. Elon Musk talked about chip shortage in the latest Tesla earnings call. Based on this, I do think that companies are ready to pay more for the semiconductors and this could positively effect the semiconductor manufacturers like AMS. If you want to have more info here are few of the articles:
Global Chip Drought Hits Apple, BMW, Ford as CJrisis Worsens - Bloomberg

Ford Sees $2.5 Billion Chip Shortage Cost, Lowers Outlook (yahoo.com)

This chip shortage obviously affected the stock prices of chip manufacturers. One of the biggest is TSM the price of which increased in 1 year from around 55 to 120 USD, so more than doubled. One would assume that the trade is already over. But check the 1 year chart of AMS:

Obviously there is a reason for this underperformance, so let's discuss few of those reasons/risks of the investment:


1) Just before the pandemic hit, AMS acquired OSRAM (light solutions manufacturer). Osram was a bigger company, so AMS had to take on a lot of debt. A lot of debt obviously not welcomed by the market when the pandemic started, as it was deemed that this is the end of the world and companies with a lot of debt will all go bankrupt. Share price slipped from 30 to around 10 CHF. Now we know that this is not the end of the world, that demand for semiconductors came back and company should be earning good money. Additionally part of the debt was convertible (i.e. holders had an ability to convert debt into additional shares). If they would use the option, your % holding of the company would decrease, hence the price of the shares also took that into account. This risk of dilution got recently solved with AMS buying back the convetible debt: Convertible bond buy-back | ams

The market price though did not react on this almost at all and I think it is just overseen as the actual buy back will happen throughout the year.

2) AMS despite record revenues in 2020 posted a loss for the year and mostly linked to the one-off expenses linked to the purchase of OSRAM. This is though the one-off loss. Indeed interest expense on the debt issued for the purchase of OSRAM will continue to be in the books, but we can see the company already repaying debt earlier. This can only say that the business feels very well in Q1 2021 (thought results are not published yet).

3) After the acquisition AMS got into legal problems with OSRAM as part of OSRAM investors were challenging the acquisition that further added pressure to the share price. This issue again was resolved this year, but the stock price did not appreciate and reverse the prior fall. So this is not a risk anymore, but the stock price still reflects it, hence adds to my idea that the stock is misspriced.

4) Share price stated to recover, but the recovery was slower, as OSRAM was deemed by the market as a big old "boring" company that produces light bulbs. Thus the multiple of AMS decreased from the level of growth companies, to something lower. In fact, OSRAM is also a transforming business, they are also manufacturing Opto Semiconductors and a number of LED products for car manufacturers, constructions, etc. LED lamps are now everywhere as the older bulbs are less energy efficient and reliable. Also LED lamps are more complex technically (hence bigger barriers for entry for competitors) and provide higher margins (price for a car lamp (with all the sensors built in in them today) are sometimes around 1,000 USD. AMS bough OSRAM tocombine the R&D and remain the leader in optical sensors, 3D sensors market. I think the market though assumes that OSRAM is not a growth company. Recent OSRAM results though show that the company can generate 15% EBIDTA margin and net income growth of 369%!!! (OK, Q1 2020 was the quarter when pandemic started, but still).q1-21-earnings-release-en.pdf (osram-group.com)

5) AMS is know for being one of the suppliers of Apple and it is deemed that Apple is the main customer that brings around 30% of revenues for AMS. The risk is that Apple tries to cut costs and start to manufacture its own chips and sensors. Here are the news. The main dips on the chart linked to the news that Apple will try to cut out AMS as a supplier. The funny thing that the stock fell like 3 times on the same news. I ignore this risk due to few reasons:
a) as stated above with current chip shortage I do not see Apple making the move anytime soon.
b) AMS has actually diversified and already works with other phone companies: Apple supplier AMS surges 20% as it diversifies to Android phones (cnbc.com)

c) AMS is not only about phone sensors, but also diversified to car sensors:Sensor supplier AMS wins Great Wall business (autonews.com) This agreement will start working in 2022, so company has room to grow in the future.

Conlussion: Having sad the above it is worth noting that Chip shortage is a temporary problem. Chip manufacturing is a cyclical business. Eventually enough money will be invested in the chip manufacturing and there will be too many semiconductors. Also eventually Apple indeed can stop purchasing AMS products, but there is still few years before that happens.

Global chip shortage likely to last through 2021 and even into 2022 as industry grapples with increasingly complex market forces | South China Morning Post (scmp.com)

Now let's talk about the upside potential, possible tailwinds for the stockprice:

1) Partially discussed in the introduction, but the chip shortage basically means that the company can sell all its chips and possibly to different companies, as there are shortages everywhere. I also assume that company could increase prices, hence improove their profit margin. The example of this is the company Qualcomm (QCOM). Also a semiconductor company (though concentrated on 5G) that yesterday reported its Q1 results:
Qualcomm Quarterly Sales Surge Driven By Smartphones Demand (yahoo.com)

Qcom stock is up more than 3% today (opened 5% higher). QCOM has one of its main customers Apple as well. As Sales surged due to smartphone demand and AMS provides also semiconductors for phones (just different type) - we can expect same great results for AMS.

2) Companies in Semiconductor industry have a P/E ratio of around 30 (range from 25 and up to 50). The P/E ratio is not available for AMS currently, as last year company finished with a loss due to one-off expenses discuss in the risk number 2.

But if we dig a bit into the results of 2020, we can find that adjusted earnings per share of AMS (adjusted to exclude one-off expenses) was 1.26 USD. Refer to page 10 of the report if you need details:
PR template_EN (ams.com). Applying the 30 multiple on it gives us a price of 37,8 USD or 34.36 CHF compared to 16 currently, so a potential 2x already with prior year earnings.

We can now discuss that the revenues and margins could increase due to shortage of chips or that the interest expense could be lower due to repayment of debt (discussed above). But to be conservative, we can expect a price of 30 CHF (again trades at 16 now).

3) As you know Bidens infrastructure plan includes the investment in semiconductor industry, as it is now deemed the industry that is almost required for national security. The chip shortage showed that relying on China and Taiwan manufacturers could have critical consequences, especially in case of any conflicts. Same understanding has the European Commission, that welcomed few days ago the statement from Member states that 20% of the European Recovery and Resilience plans should go to digital transition; this is up to 145B€ over the next 2 to 3 years. This will include spending on semiconductors. Part of this amount could eventually go to AMS as one of the main semiconductor players in Europe. Details here:
JointDeclarationonProcessorandSemiconductorTechnologiespdf.pdf

I am long this company shares from 18 CHF, so I am currently down on my position. I bought at 18 as the stock had a good support at 18, but it recently dropped to 16 and I think that now the price is even better. So unlike the MAC play discussed above, this one has even a better entry point.

As mentioned before, you just need to be careful with the cyclicality of the industry, so remember that the stock might be a good hold for the next 1-2 years or once the P/E multiple is simmilar to the industry average.

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