Axcelis Q4: Becoming More Constructive, But Some Risks Remain (ACLS)

Introduction

Back in June 2023, we wrote a piece on Axcelis Technologies (NASDAQ:ACLS), a specialist in ion implantation technology, when it was flourishing at around lifetime highs. Whilst we appreciated some facets of the business (and still do), we were less certain of its ability to generate ample alpha at those lofty levels, and hence went with a HOLD rating back then.

Since then, the stock has given up over 30% of its value, and whilst some risks still remain, we are now prepared to be more bullish on the stock’s prospects at current levels.

Here are a few reasons why we feel ACLS may be worth looking at.

Reasons To Turn More Constructive

After a lull in semiconductor-related CAPEX spending, which likely declined by 23% last year, things are now convalescing (although momentum will likely kick in only in H2), with CAPEX spending expected to grow at 1.3% this year, followed by a more expansive rate of nearly 10% in FY25 (source: Gartner). Axcelis looks well-positioned to benefit from this recovery, as the Ion implantation technology that the company specializes in, serves as a vital step in high-volume manufacturing, by augmenting the surface of wafers and making them more resistant to wear-and-tear.

ACLS’s ion implantation niche will most keenly be felt with power device applications (which is one of the most implant-intensive segments), and this could help it to deliver steady business for large parts of this year, even as the memory and mature segments start making a more meaningful comeback in H2.

Granted, topline growth this year will likely only be flattish, but it is worth considering that ACLS still had a fairly resolute backlog of $1.2bn as of the start of this month; this typically takes 12-18 months to execute, so FY25 revenue prospects are still looking solid enough at double-digit growth levels.

All in all, ACLS is still on course to hit its $1.3bn sales target for FY25, and investors should also consider the changing texture of ACLS’s sales profile. As things stand, note that ACLS’s installed base of tools is well over 3000 now, and that also translates to a useful fillip for the company’s CS&I segment (Customer solutions & innovations) which deals with aftermarket service and support, maintenance work, and crucially equipment upgrades. This type of work is innately higher margin and should help translate to a better group margin over time. For context, CS&I only contributed single-digit revenue a few years, back but by next year, it is expected to contribute around $0.3bn of the total $1.3bn target for FY25 (close to a quarter of total revenue).

Over time, we’ve seen ACLS’s gross margin pick up from the threshold seen in 2021, and the target for FY25 is a level of over 45%. Besides a higher proportion of CS&I, ACLS’s gross margins will also benefit from the company leveraging AI and augmented reality to pursue lean manufacturing, and also some renewed focus on low-cost sourcing.

We also think the recent thrust of the Purion Power series in the Japanese markets is something that could prove to be a dark horse over time, given the impetus by the Japanese government to beef up its semi competence beyond the materials landscape. The country is now looking to expand its semiconductor capacity and has set out an ambitious target of generating 2nm chips in 3 years’ time. On the Q4 call, ACLS Management mentioned that they were in conversations with multiple Japanese customers in other market segments as well.

The other thing to note is that the stock already yields quite a competitive FCF figure of nearly 5%, which is around 80bps higher than its 5-year average.

However, it looks like there could be upside risks to that yield number, as ACLS’s FCF margin (FCF as a function of sales) looks poised to double from the 12% levels seen last year to around 25% in less than 2 years.

We also appreciate the current risk-reward on both the standalone and relative strength charts.

On ACLS weekly chart, note that the stock went through a strong downtrend from September last year till around November; since then, we’ve seen the steepness of the downtrend give way to some choppiness within a certain range. We’ve seen this range work as a congestion zone from Feb to May 2023, and one could well see history repeat itself again.

Investors should also note that ACLS has ample cash on its books (now at record levels of over half a billion), and management has stated that it does not have any plans to indulge in M&A until FY25. This opens up the prospect of increased fervor with share buybacks which could end up supporting the share price. Note that in August last year., the board had approved an additional $200m of funding for buybacks, and in Q4, the company deployed around $15m towards this objective,

The long case is further strengthened by the prospect that ACLS looks like a good candidate that could benefit from rotational interest within the semiconductor space. The chart below highlights how ACLS’s relative strength figure versus other a diversified portfolio of semiconductor stocks is now around 30% off the mid-point of its long-term range.

A Few Unfavorable Facets

Even though the stock has pulled back quite significantly, it is questionable if forward valuations are still compelling enough. Based on the FY25 EPS, ACLS is currently priced at a forward P/E of 13.8x, which represents an 8% premium over the stock’s 5-year average.

Admittedly, some investors won’t be averse to shedding out a premium multiple if the quality of earnings growth is resilient enough, but it looks like on a 2-year CAGR basis (FY23-FY25), this business will likely only deliver earnings growth of 7%, leading to a sub-optimal implied PEG of 1.6x.

Another key risk to be mindful of is ACLS’s growing exposure to China. Last year, China accounted for 46% of their system revenue, and in FY24, this share may well extend to 60% (or drop to 40% which is still quite meaningful). This is a terrain that remains vulnerable to more pronounced trade tensions, regardless of a Biden or Trump victory in November.

It’s also not particularly encouraging to note that the smart money hasn’t utilized this corrective phase to add positions in the ACLS counter. Rather, if anything they continue to shed their stake even in 2024. For context, over the last 6 months, they’ve reduced their stake in this stock by 9%.