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No Surprises In SMART's (NASDAQ:SGH) Q1 Sales Numbers, Stock Soars


Full Report / January 09, 2024

Semiconductor maker SMART Global Holdings (NASDAQ:SGH) reported results in line with analysts' expectations in Q1 FY2024, with revenue down 41.1% year on year to $274.2 million. The company expects next quarter's revenue to be around $285 million, coming in 2.9% above analysts' estimates. It made a non-GAAP profit of $0.24 per share, improving from its profit of $0.10 per share in the same quarter last year.

SMART (SGH) Q1 FY2024 Highlights:

  • Market Capitalization: $945.6 million
  • Revenue: $274.2 million vs analyst estimates of $275 million (small miss)
  • EPS (non-GAAP): $0.24 vs analyst estimates of $0.16 ($0.08 beat)
  • Revenue Guidance for Q2 2024 is $285 million at the midpoint (raised from previous), above analyst estimates of $276.8 million
  • Free Cash Flow of $26.83 million, similar to the previous quarter
  • Inventory Days Outstanding: 99, up from 71 in the previous quarter
  • Gross Margin (GAAP): 30.2%, up from 25.4% in the 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 unremarkable, averaging 11.8% annually. This quarter, its revenue declined from $465.5 million in the same quarter last year to $274.2 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).

SMART Total Revenue

SMART had a difficult quarter as revenue dropped 41.1% year on year, missing analysts' estimates by 0.3%. This could mean that the current downcycle is deepening.

Product Demand & Outstanding Inventory

Days Inventory Outstanding (DIO) is an important metric for chipmakers, as it reflects a business' capital intensity 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.

SMART Inventory Days Outstanding

This quarter, SMART's DIO came in at 99, which is 23 days above its five-year average, suggesting that the company's inventory has grown to higher levels than we've seen in the past.

Pricing Power

In the semiconductor industry, a company's gross profit margin is a critical metric to track because it sheds light on its pricing power, complexity of products, and ability to procure raw materials, equipment, and labor. SMART's gross profit margin, which shows how much money the company gets to keep after paying key materials, input, and manufacturing costs, came in at 30.2% in Q1, up 4.8 percentage points year on year.

SMART Gross Margin (GAAP)

SMART's gross margins have been trending up over the last 12 months, averaging 28.1%. This is a welcome development, as SMART's margins are below the industry average, and rising margins could suggest improved demand and pricing power.

Profitability

SMART reported an operating margin of 9.7% in Q1, down 2.1 percentage points year on year. Operating margins are one of the best measures of profitability because they tell us how much money a company takes home after manufacturing its products, marketing and selling them, and, importantly, keeping them relevant through research and development.

SMART Adjusted Operating Margin

SMART's operating margins have been trending down over the last year, averaging 10.2%. This is a bad sign for SMART, whose margins are already below average for semiconductor companies. To its credit, however, the company's margins suggest modest pricing power and cost controls.

Earnings, Cash & Competitive Moat

Wall Street expects earnings per share to decline 10% over the next 12 months, although estimates will likely change after earnings.

Although earnings are important, we believe cash is king because you can't use accounting profits to pay the bills. SMART's free cash flow came in at $26.83 million in Q1, up 131% year on year.

SMART Free Cash Flow

As you can see above, SMART produced free cash flow of $171.6 million in the last year, which is 11.7% of revenue. It's good to see SMART generate positive free cash flow since it allows the company to strengthen its balance street, but we'd be uncomfortable if its FCF margin dropped any lower.

Return on Invested Capital (ROIC)

We like to track a company's long-term return on invested capital (ROIC) in addition to its recent results because it gives a big-picture view of a business's past performance. It also sheds light on its management team's decision-making prowess and is a helpful tool for benchmarking against peers.

SMART's poor returns on capital over the last five years suggest it struggled to find compelling reinvestment opportunities. The company's five-year average ROIC was negative 0.3%, meaning it's lost money on its investments. This performance was among the worst in the semiconductor sector.

Key Takeaways from SMART's Q1 Results

We were impressed by SMART's strong gross margin improvement this quarter. We were also excited its EPS outperformed Wall Street's estimates. While revenue missed by a small margin, full year revenue outlook was raised, which is a major positive. Zooming out, we think this was solid quarter, showing that the company is staying on track. The stock is up 8.2% after reporting and currently trades at $20 per share.

Is Now The Time?

When considering an investment in SMART, investors should take into account its valuation and business qualities as well as what's happened in the latest quarter.

We cheer for everyone who's making the lives of others easier through technology, but in the case of SMART, we'll be cheering from the sidelines. Its revenue growth has been mediocre over the last three years, and analysts expect growth to deteriorate from here. On top of that, its relatively low ROIC suggests it has struggled to grow profits historically, and its gross margin indicate some combination of pricing pressures or rising production costs.

SMART's price-to-earnings ratio based on the next 12 months is 14.8x. 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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