Semiconductor maker SMART Global Holdings (NASDAQ:SGH) reported results ahead of analyst expectations in the Q3 FY2023 quarter, with revenue down 17.1% year on year to $383.3 million. The company expects that next quarter's revenue would be around $375 million, which is the midpoint of the guidance range. That was roughly in line with analyst expectations. SMART made a GAAP loss of $24.1 million, down on its profit of $24.5 million, in the same quarter last year.
SMART (SGH) Q3 FY2023 Highlights:
- Revenue: $383.3 million vs analyst estimates of $375.1 million (2.21% beat)
- EPS (non-GAAP): $0.66 vs analyst estimates of $0.40 (63.6% beat)
- Revenue guidance for Q4 2023 is $375 million at the midpoint, below analyst estimates of $377.6 million
- Free cash flow of $27.8 million, down 68.4% from previous quarter
- Inventory Days Outstanding: 72, down from 86 previous quarter
- Gross Margin (GAAP): 25.7%, up from 24.7% same quarter last year
Based in the US, SMART Global Holdings (NASDAQ:SGH) is a diversified semiconductor company offering memory, digital, and LED products.
SMART was founded in 1988 by Mukesh Patel and went public went public for the first time in 1995. It was then acquired by both strategic (Solectron) and financial (Silver Lake) buyers, taken private and then public again in 2017.
SMART’s product portfolio is divided into three segments: Memory Solutions, LED Solutions, and the emerging Intelligent Platform Solutions (“IPS”). The Memory Solutions segment, upon which the company was built, designs and manufactures DRAM (dynamic random access memory) and flash memory for computers, servers, and smartphones. The LED Solutions segment consists of application-optimized LEDs (light-emitting diodes) focused on the density, intensity, and reliability of lights in video screens, gaming displays, etc. The IPS segment is a portfolio of hardware, software, and services to enable edge computing. For example, SMART IPS architected and manages a private hybrid cloud environment (nodes, storage, etc.) for a US Federal government customer to enable AI and analytics use cases.
While SMART does not operate wafer fabrication facilities, the company has facilities in Brazil, the US, China, and Malaysia for subsequent stages of semiconductor manufacturing. These facilities receive unmounted chips and package die into semiconductor and LED components. Testing and assembly also occurs in these facilities.
While no company offers the same diversified product portfolio, some competitors include Intel (NASDAQ:INTC), Dell (NYSE:DELL), NVIDIA (NASDAQ:NVDA), and SK hynix (KOSE:A000660).Sales Growth
SMART's revenue growth over the last three years has been solid, averaging 18.7% annually. But as you can see below, last year quarterly revenue declined from $462.5 million to $383.3 million. Semiconductors are a cyclical industry and long-term investors should be prepared for periods of high growth, followed by periods of revenue contractions (which can sometimes offer opportune times to buy).
Despite SMART revenues beating analyst estimates, this was still a slow quarter with a 17.1% revenue decline.
SMART's looks headed into the trough of the semi cycle, as it is guiding to revenue declines of 14.3% YoY next quarter, and analysts are estimating 3.79% declines over the next twelve months.
Product Demand & Outstanding Inventory
Days Inventory Outstanding (DIO) are an important metric for chipmakers, as it reflects the capital intensity of the business and the cyclical nature of semiconductor supply and demand. In a tight supply environment, inventories tend to be stable, allowing chipmakers to exert pricing power. Steadily increasing DIO can be a warning sign that demand is weak, and if inventories continue to rise the company may have to downsize production.
This quarter, SMART’s inventory days came in at 72, 2 days below the five year average, showing no indication of an excessive inventory buildup at the moment.
Pricing Power
SMART's gross profit margin, how much the company gets to keep after paying the costs of manufacturing its products, came in at 25.7% in Q3, up 1 percentage points year on year.
SMART's gross margins have been stable over the past year, and while at 25.5% they remain below other semiconductor companies, the trend is pointing to a stable pricing environment.
Profitability
SMART reported an operating margin of 9.47% in Q3, down 2.3 percentage points year on year. Operating margins are one of the best measures of profitability, telling us how much the company gets to keep after paying the costs of manufacturing the product, selling and marketing it and most importantly, keeping products relevant through research and development spending.
Operating margins have been trending down over the last year, averaging 11%. Not a great indicator for SMART, whose operating margins are amongst the lowest for semiconductors, caused by only a modest competitive advantage and a relatively inefficient operating model.
Earnings, Cash & Competitive Moat
Wall St analysts are expecting earnings per share to decline 29.7% over the next twelve months, although estimates are likely to change post earnings.
Earnings are important, but we believe cash is king as you cannot pay bills with accounting profits. SMART's free cash flow came in at $27.8 million in Q3, roughly the same as last year.
SMART produced free cash flow of just $42.1 million in the last year, which is only 2.45% of revenue. We think shareholders would want to see free cash flow improve as a percentage of revenue.
Over the last 5 years SMART has reported an average return on invested capital (ROIC) of just -3.48%. This suggests it may struggle to find compelling reinvestment opportunities within the business.
Key Takeaways from SMART's Q3 Results
With a market capitalization of $1.29 billion SMART is among smaller companies, but its more than $401.3 million in cash and positive free cash flow over the last twelve months give us confidence that SMART has the resources it needs to pursue a high growth business strategy.
We were very impressed by the strong improvements in SMART’s inventory levels, which could signal positive things to come as it is often a sign of where a semis company sits in the cycle. And we were also excited to see that EPS (earnings per share) outperformed Wall St’s expectations. On the other hand, it was less good to see some deterioration in operating margin. Additionally on the negative front, revenue guidance for the next quarter missed analysts' expectations. However, EPS guidance beat. Lastly, the CEO reminded investors that the June 13th sale of 81% interest in SMART Brazil continues the company's "transformation to a high-performance, high-availability enterprise solutions company, and believe we are positioned to benefit from emerging trends in AI, machine learning and data analytics." Zooming out, we think this was still a decent, albeit mixed, quarter, showing the company is staying on target. The company is up 5.38% on the results and currently trades at $28.03 per share.
Is Now The Time?
When considering SMART, investors should take into account its valuation and business qualities, as well as what happened in the latest quarter. We cheer for everyone who is making the lives of others easier through technology, but in the case of SMART we will be cheering from the sidelines. Its revenue growth has been solid, though we don't expect it to maintain historical growth rates. Unfortunately, its its relatively low return on invested capital suggests suboptimal growth prospects, and its gross margin indicate some combination of pricing pressures or rising production costs.
SMART's price to earnings ratio based on the next twelve months is 13.3x. While we have no doubt one can find things to like about the company, and the price is not completely unreasonable, we think that at the moment there might be better opportunities in the market.
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