Nova: Support Needs To Hold

Nova (NASDAQ:NVMI), a supplier of metrology and process control tools for the semiconductor market, has managed to extend the run that can be traced back to late last year. This has happened even though NVMI has entered an earnings downturn due to a drop in demand in large parts of the semiconductor industry. However, the stock has lost steam in recent weeks and NVMI needs to change course or it may risk falling below support. Why will be covered next. I last covered Nova in April this year.

The stock is challenging support

The chart below shows how NVMI has experienced a major turnaround in the last nine months or so. The stock hit a 52-weeks lows of $67.40 on October 13, but things changed from that point on. NVMI stock rallied in the following months, culminating in a 52-weeks high of $119.61 on June 13 or eight months later. The stock is up 36.6% YTD.

However, note how the stock has pulled back in the weeks following June 13. The stock is not only off the highs, but it also seems hellbent on breaking through $110 or so given the number of attempts. The stock has been unsuccessful thus far though. The stock has made repeated attempts to break through the $107.50-112.50 region in the past few weeks, but on each attempt the stock backed off to end the day off the lows.

It appears there is something in the $107.50-112.50 region that is keeping the stock afloat and preventing it from going lower. This is most likely due to support in the $107.50-112.50 region, because this is not the first time the stock has pivoted in this region. Recall how the $107.50-112.50 region is the same region where the stock used to encounter resistance in the past, including as recently as August of last year.

In fact, the stock has encountered support and resistance on numerous occasions in the last two years in the $107.50-112.50 region. For instance, the stock was unable to get past the $107.50-112.50 region in August 2022, June 2022 and May 2022. There’s therefore reason to believe the stock is currently close to support having closed at $111.59 on July 7 and given what we know of the $107.50-112.50 region from past history, especially since what used to be resistance tends to become support and vice versa.

The question now is whether support will hold, which would provide a base from which the stock could attempt to take a stab at new heights. Alternatively, it’s not impossible the stock might fall below support in the $107.50-112.50, which could be followed by a relatively quick return to the next possible support level. This could be found at $90 or so.

Could NVMI beat once again or will the market be disappointed?

It’s worth mentioning that a few potential catalysts are fast approaching. One reason why the stock has done well in recent months even though NVMI and the industry as a whole are in a downturn is because of expectations the worst is over. It helped that NVMI beat Q1 estimates for the top and the bottom line, although Q2 guidance was a mixed bag.

NVMI also adopted a wait-and-see approach as to what the second half of the year would be like, suggesting NVMI does not dismiss the possibility it may have to deal with additional challenges. Still, expectations are that the Q2 results is likely to mark the trough in the downturn. Consensus estimates expect non-GAAP EPS of $1.00 on revenue of $121.7M in Q2, which is somewhat better than the midpoint of guidance from NVMI. The table below shows what Q2 guidance from NVMI is like.

Source: NVMI Q1 FY2023 report

In comparison, the table below shows some of the numbers in the preceding quarters. Q1 experienced a significant drop in sales and profits, which is expected to continue in Q2. Note how NVMI was able to offset the drop in the top line with better margins due to a more favorable product mix and higher financial income. This helped the bottom line in Q1, but neither are expected to continue indefinitely. Cutting expenses and stock buybacks helped as well.

Guidance only covered Q2, but NVMI does seems to suggest the numbers are unlikely to get much worse than Q2, although there is a lot of uncertainty out there. From the Q1 earnings call:

“there is a lot of volatility I think in customer decisions and business in the current environment. We see projects and plans shifting between different quarters. Generally, we do believe that China will continue to be strong across the year. But obviously Memory is very, very dormant and also we see fluctuations in Logic. Overall, again, as Gabi mentioned, our goal right now is to strive for stability across the remainder of the year.”

A transcript of the Q1 FY2023 earnings call can be found here.

Why NMVI might be a tough sell

Consensus estimates expect NVMI to end up with non-GAAP EPS of $4.23 on revenue of $504M by the end of FY2023. In comparison, NVMI earned $3.85 on revenue of $416.1M in FY2021 and $5.07 on revenue of $570.7M in FY2022. The numbers are expected to get better in 2024 since the semiconductor industry is widely expected to rebound after the recent downturn. On the other hand, this may be subject to revisions, especially since semiconductor demand has generally been weaker than expected for many, although not all.

Nevertheless, some might question whether NVMI presents the best value after the rally its had. Multiples for NVMI tend to be significantly higher than competitors, including KLAC which is by far the market leader in metrology and process control tools. The table below shows some of the multiples NVMI trades at.

Source: Seeking Alpha

Will the China boost last for NVMI?

NVMI has seen its quarterly numbers drop due to the industry downturn, but not as much as some of its peers in the industry. A major reason why is because of China. According to the most recent Form 20-F, China accounted for 28% of FY2022 revenue, up from 21% in FY2021 and 19% in FY2022. Demand from China has spiked. China has thus mitigated to a certain extent the drop in demand elsewhere.

However, whether this continues remains to be seen. It’s, for instance, possible the reason why orders from China have been so robust lately is because chipmakers placed orders ahead of time to hedge against the possibility of trade restrictions. Companies might want to get their hands on machines ahead of schedule just in case they are unable to do so at a later stage.

This opens the door to the possibility demand in China got skewed. NMVI might not experience a drop in demand from China in the second half of 2023 or anytime soon, but it could happen once manufacturers in China have stocked up on the machines they need. If or when this happens is not certain, but it’s a possibility.

Investor takeaway

NVMI has done very well in the last nine months, at least as far as the stock is concerned. The stock came close to doubling off the October lows in June, although it has struggled in recent weeks. The stock has been hugging support in recent weeks, which might cause come to bite their nails. While support has held, it would still come as a relief if the stock creates some separation between itself and support, since a break below support could open the door for a bigger drop.

Business itself has not been as great as before. The downturn in the industry has hit NMVI, although not as hard as others thanks in no small part to robust orders from China. The top and the bottom line started to drop in Q1 and that is expected to continue when NMVI reports next, but the numbers are not expected to drop much further once the Q2 results are known. Income is expected to remain flat the rest of the year.

However, the outlook could change. The semiconductor market has been weaker than expected compared to early in the year and chipmakers may respond by making further adjustments by delaying or even canceling equipment orders, including from the likes of NMVI. In addition, China is somewhat of a wildcard for NMVI.

The Chinese market has been a resilient one for NVMI, but whether it is solely due to real demand remains to be seen. It’s possible China may be stocking up on semiconductor manufacturing equipment due to the possibility of trade restrictions, which could explain why China has been ordering much more than it would have under normal circumstances. If China changes its ordering patterns, NMVI might experience a drop-off in demand not currently anticipated.

While valuations for NMVI are not excessive using most metrics, some might argue they can find better value than NVMI after the run it had. The stock has ascended in the last nine months or so, even though a downturn has hit profits and some sort of correction may be in order. It’s probably no coincidence the stock has been making so many attempts to break through support lately. The stock may be tired after the run it had.

I am neutral on NVMI as stated in a previous article. NMVI may be at an inauspicious moment. Support needs to hold or the stock could drop a lot further. Multiples may be somewhat too high considering where everyone else is. The market expects the downturn to stabilize starting with the upcoming Q2 report, but if NMVI does not deliver as expected, that just may be enough to trigger a correction in the stock after the last nine months it had. Caution is appropriate.