Ultra Clean Holdings Stock: The Rally May Be Getting Long In The Tooth (NASDAQ:UCTT)

Ultra Clean Holdings (NASDAQ:UCTT), a supplier of critical subsystems, ultra-high purity cleaning and services for the semiconductor industry, has more than doubled in value since bottoming in October. The stock reached a new multi-year high shortly after the release of the Q4 and FY2023 report on February 21, only to surrender most of the day’s gain before the end of the day. In fact, the stock has exhibited indecisiveness in recent weeks, which could be a sign the rally of the last few months may be getting long in the tooth. Why will be covered next.

The stock market rallies and UCTT hitches along for the ride

A previous article from early September 2023 rated UCTT a hold for several reasons. The stock had done relatively well in the face of disappointing quarterly results, but the article nonetheless concluded that the stock was at risk of selling off. The stock, for instance, encountered stiff resistance and the stock was close to losing the support that had provided it with a certain level of resilience.

The chart above shows how the stock went on to decline in September and October to hit a low of $22.15 on October 23, 2023, a three-year low. However, UCTT turned it around with a powerful rally that took the stock to a high of $49.25 on February 22, 2024, the day after the most recent report was released.

The last time the stock was this high was in early 2022. The stock more than doubled in value in about four months. Note that this rally by UCTT coincided with a rally in the stock market as a whole, which is now at record levels. This record rally has pulled every one along for the ride, UCTT included.

Note that the high of $49.25 is close to the average price target of $49.67 for UCTT. This could explain why the stock was unable to hold on to the gains since UCTT gave back most of the gains before the end of the day on February 22. Furthermore, a look at the recent price action shows that the stock has essentially gone sideways in recent weeks, as shown in the previous chart.

Keep in mind that the stock has come a long way in recent months, having more than doubled in value. It is possible the stock is taking a rest before resuming the rally, but the more likely case is that the stock is due for a pullback, taking into account by how much the stock has risen in a fairly short amount of time.

A bad year is no more

As mentioned previously, the stock had somewhat of a change of heart after it was unable to hold on to much of the gains following the Q4 report. The stock still gained 5.2% on February 22, the day after the Q4 report was released, but that was down from a gain of as much as 16.7% at one point. The Q4 report itself came in mixed, weighed down by a decline in demand. The report did beat earnings estimates, but guidance was soft, although the outlook calling for an improvement in earnings helped offset the latter.

The consensus expected UCTT to report non-GAAP EPS of $0.12, but UCTT earned $0.19, $0.07 more than expected, on revenue of $444.8M in Q4. Still, the numbers represent a decline of 79.6% and 21.5%, respectively, YoY. In terms of GAAP, UCTT reported a net loss of $3.8M or $0.08 per share. Note that the large QoQ improvement in EPS can be mostly attributed to the effect of income taxes, which flipped non-GAAP EPS by $0.17. The table below shows the numbers for Q4 FY2023.

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Source: UCTT Form 8-K

If the Q4 numbers are out, then so too are the FY2023 numbers. In general, FY2023 was a year to forget for UCTT. FY2023 revenue declined by 27% YoY to $1,734.5M. Non-GAAP EPS declined by 85.9% YoY to $0.56 and UCTT finished with a net loss of $31.1M or $0.70 per share in terms of GAAP. UCTT ended FY2023 with cash and cash equivalents of $307M, down $51.7M YoY, but this was more than offset by $461M of bank loans on the balance sheet.

Note that UCTT closed the acquisition of HIS Innovation Group in Q4 FY2023 for $50M, in addition to another earnout payment of $50M. UCTT bought back 1.9M shares in FY2023, including 239,000 in Q4 alone. The table below shows how the numbers got worse in FY2023 versus FY2022.

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Source: UCTT Form 8-K

Guidance calls for Q1 FY2024 revenue of $430-480M, an increase of 5% YoY at the midpoint with the aid of the HIS acquisition. The forecast calls for non-GAAP EPS of $0.03-0.23, a decline of 23.5% YoY at the midpoint, and a GAAP loss of $0.05-0.25 a share, up from a loss of $0.08 one year ago.

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UCTT is not as optimistic about FY2024 as others

While UCTT is off to a sluggish start in Q1, the quarterly numbers are expected to improve as FY2024 goes by. This is because the market for semiconductor manufacturing equipment is widely expected to grow in 2024 after contracting in 2023. A recent forecast from SEMI, for example, predicts the wafer fab equipment or WFE market will grow by 3% in 2024 after contracting by 3.7% in 2023, before growing by another 18% to hit a record $110B in 2025.

UCTT should benefit from the return to growth. Remember that UCTT is a supplier to two of the biggest equipment makers, Applied Materials (AMAT) and Lam Research (LRCX). UCTT has delayed the release of the Form 10-K for FY2023, but according to the Form 10-K for FY2022, AMAT and LRCX accounted for 62.7% of FY2022 revenue at UCTT.

However, a major reason why UCTT was unable to hold on to its post-earnings gains is because UCTT was perceived to be less optimistic than others about the state of the market in the earnings call. While UCTT expects improvement before the end of the year, FY2024 is off to a slow start and demand remains tepid at the moment. From the Q4 earnings call:

“With 2024 in its early days, current demand remains tepid as reflected in our Q1 guidance. However, our internal marketing research is aligned with broader industry sentiment and our customers that overall market dynamics are improving and should help drive a stronger exit to the year.

Looking to 2025 and beyond, the business case supporting extensive investment for WFE is very compelling with global semiconductor sales widely predicted to reach $1 trillion by the end of the decade, requiring nearly twice the current capital spend.”

Source: UCTT earnings call

What FY2024 could be like for UCTT

UCTT provided some additional color where it acknowledged seeing weakness where it did not expect to, in addition to not seeing certain areas improve as expected, as recently as the last quarter.

“We do expect some improvement in the second half on the chip side, but very incremental. I think the other factors where we’re hoping for things to improve not just the exit, but starting in the second half is that the inventory situation will be better as well as the demand is now coming from areas where our footprint is stronger.

So in 2023, there was a lot of demand in the ICAP, which is mostly 200 millimeter, which is not an area of heavy contract manufacturing. There’s also very strong litho, which although we have a growing footprint there, it’s still in the single digits of our total revenue, as well as some other factors kind of affecting where the investments were coming. So we’re still seeing – in this last quarter, we’re still seeing instability, I would say. So areas that we thought we would be shipping from, some of those orders got pushed around and areas where we didn’t expect, the orders we got kind of drop in orders.

So it’s still a bit unstable. But the end result is we’re incrementally seeing a little bit better results. So we’re hopeful in the SEC, we’ll start to see it earlier in the second half as these factors come into play. But I think the safest conservative assumption is that the chip demand won’t really start taking off until near the end of the year.”

Nevertheless, UCTT is likely to have a better year in FY2024, if only because FY2023 was such a bad year with a big drop in earnings. Historically, UCTT tends to outperform the WFE market during upturns, and assuming that remains true, FY2024 revenue is estimated to grow by 12% YoY to around $1.95B.

Such an increase in the top line could result in non-GAAP EPS of $1.40 in FY2024, or an increase of 150% YoY versus FY2023’s $0.56. This would translate to a forward non-GAAP P/E ratio of 30.9x and a trailing P/E ratio of 77.1x with the stock closing at $43.20 on February 29. In comparison, the average P/E ratio in the last five years is 19x and 14x, respectively, and the sector median in the sector is 24.6x and 22.8x, respectively.

Investor takeaways

It is tempting to be long UCTT with the way the stock has soared higher in the last few months, but I am going with neutral on UCTT. The stock is technically not overbought and there is room for additional gains in the stock, but to be a buyer of a stock that has already more than doubled in value in a few months is risky, especially when the rally is built on an assumed recovery in earnings that may not happen as expected.

The stock could go higher, but it is probably due for a correction first after covering as much ground as it has. The rally, for instance, has taken the stock from a multi-year low last October to a multi-year high after just four months, which is quite the turnaround. A breather at the very least would not be a surprise, if not something more severe.

The stock itself has struggled in recent weeks. While earnings are expected to improve in FY2024 with a recovering market, especially towards the end of FY2024, comments from UCTT leave open the possibility the recovery in demand may not go as many predict it will. UCTT is still seeing difficulties with demand, even though we are a couple of months into FY2024.

UCTT trades at 77.1x trailing earnings, which is a multiple much higher than the average in the last five years for UCTT. It is also higher than most in the sector. UCTT looks better on a forward basis at 31x, but keep in mind that forward multiples are based on estimates, which may or may not be correct, whereas the trailing multiples are based on actual earnings. The recovery needs to arrive or the stock goes down with multiples where they are.

Bottom line, the expected improvement for FY2024 been priced in with the stock rally of the last few months. The risk here is that the improvement in earnings comes up short due to demand not improving as much as anticipated. If this happens, and with the stock doubling in value, the stock may have no other choice than to correct.