FormFactor: The Pros And Cons Of Going Long (NASDAQ:FORM)

It took months of sideways action, but FormFactor (NASDAQ:FORM) appears to have broken out in November on the way to a new 52-week high. The breakout seems to have benefited from a couple of favorable developments, including better-than-expected earnings. In addition, while FORM had every reason not to, especially with how earnings have gone down due to a slump in market demand, FORM’s decision to stick with its long-term financial model appears to have helped also. Why will be covered next.

FORM breaks out to new highs for 2023

A previous article from mid-September rated FORM a hold after concluding the stock’s sideways action that had already gone on for months by then could continue. However, while the sideways action did continue in September and October, that all changed a few weeks ago. The chart below shows how the stock hit a new 52-week high of $39.76 on November 20 after spending months going sideways.

However, it’s worth mentioning that, while the stock hit a new high recently, the stock has trended higher for over a year after bottoming at $18.15 in November 2022. The stock has more than doubled in value to close at $37.90 on November 24, 2023 for a gain of 70.5% YTD. If trendlines are drawn to connect all the lows and the highs, it can be observed that while the lows and highs are pointing higher, FORM now finds itself toward the upper bound of the uptrend. This suggests the stock is more likely to be going lower than higher in the short term.

The rally has also pushed up multiples, which may now be too high for some people. For instance, FORM trades at 53 times forward non-GAAP earnings with a trailing P/E of 67. In comparison, the median in the sector is 23x and 20x, respectively. The table below shows some of the more commonly referenced multiples for FORM.

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Source: Seeking Alpha

Future growth may already be priced in

Notice how the stock jumped 9.9% on November 10, a day after FORM held the first of several investor conferences planned for November. These conferences come against a backdrop of FORM dealing with various headwinds, which have put pressure on the top and the bottom line for some time. For instance, FORM has seen quarterly revenue decline YoY for five consecutive quarters.

This after an extended period in which revenue grew YoY for 15 consecutive quarters. The last 20 quarters or five years have been a story of opposites. FORM did well for a long time, but not so much recently. It thus stood to reason that FORM might consider lowering its outlook in line with recent headwinds, but FORM mostly stuck with its previous viewpoints in the presentations.

The market appears to have given the thumbs up to FORM for doing so. Among other things, FORM emphasized in the presentation its good prospects in the coming years, present headwinds notwithstanding. Test intensity, for instance, is expected to go up in the coming years, which should raise demand for probe cards from vendors like FORM.

FORM stuck with its financial model, which targets revenue of $850M, non-GAAP gross margin of 47%, and non-GAAP EPS of $2.00. In comparison, FY2023 revenue stands at $494.4M, gross margin at 40.3%, and EPS at $0.53, all YTD after three quarters. Still, if we assume FORM hits $2.00 in earnings as aimed for and if we assign a P/E multiple of 20, the median for the sector, then this would imply a price target of $40 for FORM. This could help explain why the stock has rallied in the month of November to a 52-week high of $39.76, or close to $40, before pulling back.

FORM is showing green shoots

True, FORM has a lot of work to do to hit non-GAAP EPS of $2.00 on revenue of $850M. FORM remains in a cyclical downturn, which it acknowledges. However, there are some signs the worst may have passed. While demand has yet to take off, the bottom may already be in. From the Q3 FY2023 earnings call:

“While we continue to operate in a cyclical downturn and see no near term acceleration of demand, we’re encouraged by broader signs of bottoming in our most important high unit volume end markets like client PC and mobile.”

A transcript of the Q3 FY2023 earnings call can be found here.

Another headwind FORM has faced in recent quarters is China. China sales are dropping, in part due to export controls imposed by the U.S. government. FORM believes this is likely to continue.

“Our China business, I think, was again down sequentially, and probably at half the levels it was at the peak back in late ’21 or early ’22. To answer your question directly, it’s almost entirely structural. As a US supplier operating at advanced nodes that are subject to expert controls from the Department of Commerce, we’ve been limited in our ability to supply customers. And I think we’ve been quite clear in our expectations that we expect the domestic China business to continue to increase and at some point here, probably go to zero”

Still, the latest quarterly results offer encouraging signs FORM is past the trough. Revenue and non-GAAP EPS declined YoY, but they also increased QoQ. In Q3 FY2023, FORM earned $0.22 in non-GAAP earnings on revenue of $171.6M, which was well ahead of expectations since the consensus was calling for $0.17 on revenue of $167M. The table below shows the numbers for Q3 FY2023.

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Source: FORM Form 8-K

Guidance calls for Q4 FY2023 revenue of $160-170M, slightly less than a year ago at the midpoint. Keep in mind this is without contributions from the metrology business, which was recently sold to Camtek (CAMT) for $100M in cash, or $95M in terms of net proceeds. The transaction is expected to close in Q4 FY2023.

If not for the sale, Q4 guidance would show a YoY increase in revenue. The forecast sees non-GAAP EPS of $0.16-0.24, an increase of 300% YoY at the midpoint, and GAAP EPS of $0.80-0.88, up from a loss of $0.18 one year ago. Note that the huge increase in the latter is primarily the result of the aforementioned sale and its cash infusion.

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Source: FORM Form 8-K

The cash infusion will add to cash reserves, which currently consist of $108.7M of cash and cash equivalents and another $135.7M in marketable securities. This could serve to finance additional stock buyback programs on top of the ones currently running.

Could AI keep giving FORM a lift?

FORM is projected to end up with non-GAAP EPS of $0.73 and revenue of $659.9M in FY2023. In comparison, FORM earned $1.25 on revenue of $747.9M in FY2022. The numbers have declined, which is understandable since semiconductor demand is down in general, including in logic and memory in particular. Most industry forecasts predict the semiconductor market will contract in the low teens in 2023.

Yet, FORM has seen its stock soar by 70.5% YTD in 2023. In contrast, the iShares Semiconductor ETF (SOXX) has gained 48.3% YTD in 2023. FORM has done much better than most semis. While several factors were involved, an important factor in making this possible was the perception of FORM being a beneficiary of the boom in AI.

It’s, for instance, probably no coincidence the stock peaked on November 20, a day before NVIDIA (NVDA) released its latest earnings report. The proliferation of AI applications is expected to lead to increased demand for, among other things, HBM memory. HBM memory is very test intensive, which is seen to be a boon for FORM, especially with SK Hynix, the leading supplier of HBM memory, sourcing its test probes from FORM.

FORM has thus become an AI play and this could continue as long as interest in AI and related beneficiaries remains high. Still, if not for the rise of AI in 2023, FORM would very likely not have outperformed the way it has in 2023. AI has covered up some of the warts on stocks, but that does not mean the warts are not there.

Investor takeaways

There are certainly arguments to be made in favor of long FORM. The stock appears to be in an uptrend and there is a saying the trend is your friend. While it may be too early to say the downturn has ended or an upturn has started, the quarterly numbers seem to be getting better after an extended slump that has seen quarterly revenue shrink YoY for the last five quarters.

There are some signs semiconductor demand is improving, at least in some segments. For instance, prices for DRAM and NAND are inching up, which suggests demand is getting stronger, something that could revive the memory segment at FORM. All this, together with the optimism about future prospects, as expressed by the financial model laid out in recent presentations, argue in favor of long FORM.

However, FORM may already be fairly valued or not fair away from it, and that’s assuming FORM manages to hit non-GAAP EPS of $2.00 a share by growing much faster than it has in reality. If FORM does not because the downturn continues, then FORM looks expensive, especially with multiples where they are, far higher than most semis. The stock has rallied higher for a whole year, which suggests the rally may be long in the tooth and due for something else.

AI has given FORM a powerful lift and that is likely to continue for the time being since there is no end in sight for the AI boom. Still, some might wonder if there is too much exuberance associated with AI, which could backfire over time. Keep in mind that AI has yet to significantly move the needle for the likes of FORM, which has actually seen earnings drop during the supposed AI-induced boom. This may be why some may consider reducing exposure to AI plays like FORM, if not eliminating it entirely.

I am neutral on FORM. While some may decide long FORM is the way to go, especially since doing so has paid off very handsomely in 2023, not everyone is likely to agree for a number of reasons as mentioned above. The AI craze is likely to push the stock higher in the short term, but always remember that no matter what, nothing goes up forever.