Anthony Garcia Games SGH

SMART Global Holdings Is Undervalued, Expanding And Relatively Safe From Recession – SMART Global Holdings (NASDAQ:SGH)

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A Inventory Able to Reward Lengthy-Time period Holders

SMART Global Holdings (NASDAQ:SGH) has positioned itself very properly to reward shareholders sooner or later and I see it being a superb alternative for an extended-time period maintain.

This is the fast breakdown after which I am going to get into it a bit additional.

The Good:

  • They’re the chief within the rising financial system of Brazil for specialty reminiscence – an financial system that simply got here out of a recession and is increasing.
  • They acquired Penguin Computing – giving them new distribution strains, authorities and enormous company contracts, and an enormous step within the door for synthetic intelligence.
  • FY 2018 was the primary yr they made cash they usually had large progress in doing it, and the general market hasn’t reacted to that in full, leaving a worth alternative.
  • Their financials point out a ahead wanting administration staff – extra on this down under.

The Not-So-Good:

  • They seem to be a small firm (market cap of $781M) and should not have the ability to journey out each storm.
  • They carry a whole lot of debt at 98.Four% lengthy-time period debt to fairness.
  • Their gross margins are low in comparison with the remainder of the business.
  • They’re in an business that is seeing its peak within the cycle proper now in the USA.

The Good

Brazil

SMART has established itself as a market chief as the most important in-nation producer of cellular reminiscence merchandise for smartphones, and the most important in-nation producer of reminiscence elements and modules for desktops, notebooks, and servers.

From SGH’s Investor Relations Web page

At present Brazil is the world’s eighth-largest financial system (by GDP), popping out of a recession final yr and rising once more. The market phase that SGH operates in is wanting very robust with numerous alternatives for additional progress:

  • At present 54% of Brazilian adults personal a smartphone, with the entire quantity almost doubling yearly since 2013. (Supply)
  • Tablets are highly regarded with virtually 15% of the nation utilizing them to entry the web – making Brazil the third most “tabletized” nation on the planet. (Supply)
  • PC gross sales are up 21% quarter over quarter for 2018 with the primary quarter seeing 1.34 million computer systems bought; 60% being notebooks and the remaining desktops. (Supply)

These units all require specialty reminiscence to be fitted to their specs together with velocity, capability and type issue. With a view to do this many occasions “off the shelf” merchandise won’t work, and the OEM corporations that make these units might want to work with corporations like SGH with a purpose to fulfill that requirement. A notable exception to that is many desktop PCs, nevertheless SGH can present elements for these as properly and does associate with OEMs on this entrance. General their specialty reminiscence phase is up 20% yr-over-yr.

Additionally of notice is that they’ve started producing polymer cell-based mostly batteries for smartphones in Brazil – with an estimated market of round $400m in that nation. This exhibits a superb use of present amenities to proceed to broaden and it goes properly with their different product strains as a way to increase the quantity of merchandise they will supply to their clients.

Their Brazilian operation represented 61.eight% of their complete income for FY18 (supply).

Penguin Computing

SMART… introduced that it has acquired Penguin Computing, Inc., a privately held firm and a pacesetter in specialty compute and storage options concentrating on purposes in Synthetic Intelligence, Machine Studying and Excessive-Efficiency Computing utilizing state-of-the-artwork, open applied sciences and superior business architectures.

From SGH’s Press Launch on the Penguin Acquisition

If you’ll navigate to the above hyperlink you will see a few of Penguin’s monetary knowledge on the backside. In FY17 that they had a gross revenue of $30m, they usually had grown their internet gross sales and gross margin by 80% and 77%, respectively, from Q1.FY17 to Q1.FY18. They completed Q1.FY18 with a modest backside line of $2m as in comparison with Q1.FY17 at $Zero.4m giving them a 5-fold improve quarter-over-quarter.

Penguin was being profitable by itself and can solely add to SMART’s backside line at this level. I am not a fan of corporations that do not generate income, so it is good to see this acquisition was an instantaneous increase to the underside line revenue. SGH has said Penguin can be accretive to EPS in FY19.

Taking over Penguin Computing provides them a lot of new alternatives:

  • New strains of distribution for present merchandise. Penguin supplies customized computing options for enterprise and authorities purposes and this simply permits SGH to offer specialty reminiscence for all of those gross sales.
  • Authorities and enormous company contracts to offer excessive-efficiency computing synthetic intelligence, giving them a further secure supply of revenue shifting ahead.
  • A foot within the door with AI analysis and improvement. Penguin is partnering with Nvidia (NVDA) and Intel (INTC), two of the leaders in AI. I personally consider investing in AI now’s a incredible concept for the long run.

All of this taken collectively signifies that Penguin shall be extremely supportive of their present enterprise construction and supply them with new avenues to proceed to broaden.

Supply for the above.

Progress or Worth?

On OCT-Four-2018 SMART reported its FY18 outcomes and steerage for FY19. It was nothing in need of staggering in comparison with the place they’d been, and the inventory worth mirrored it. Let’s dive in to the nitty gritty.

First off they beat FY17 by 69% on internet gross sales (as much as $1,289m over $761m) and in doing so set their FY18 EPS at 5.17 (GAAP) over FY17’s at -Zero.38.

What’s much more spectacular is that they made actual money for the primary time and the underside line seems to be like a wholesome small firm simply beginning to flip an excellent revenue. As I discussed earlier than I can’t advocate or buy a inventory that does not generate profits. Let us take a look at the underside line right here.

Fiscal Yr FY18 FY17 FY16 FY15 Internet Revenue (Loss) $M 119 (eight) (20) (46)

(Supply)

Within the earnings name (transcript) additionally they issued steerage on Q1 FY19 calling for GAAP earnings of $1.49 – $1.54 vs. Q1.FY18 at $1.05. On the excessive finish that is a 46% progress.

Now to date this seems like a progress inventory, and I might agree with that. However I feel it is progress at an inexpensive worth. Let us take a look at some extra key metrics.

Worth/Earnings PEG Ratio Worth/Gross sales Worth/Ebook Worth/Money Circulate
6.47 Zero.10 Zero.58 Four.94 5.08

(Calculated from monetary statements, inventory worth, and GAAP earnings)

P/E, PEG and P/S are very engaging (particularly when in comparison with the remainder of semiconductors). The worth/ebook is not. I do not look after that P/B, to be trustworthy. Nevertheless, provided that SGH’s enterprise mannequin focuses extremely on the service aspect of semiconductors (particularly given buying Penguin), I do not assume it is a massive issue right here.

Now let’s speak the inventory worth. On Oct. 5 they received an enormous bounce from 32.37 to 35.01 on the shut. The quantity was super on that day. Predictably on the times following some took income. It has been buying and selling in a little bit of a channel since then, however with current bullish technicals and an apparent spot of resistance at $35. Previous to the Penguin acquisition it was buying and selling round $50.

I do not assume the market priced the acquisition correctly. It seems to be to me like loads of shareholders noticed the acquisition and panicked, worrying that SGH was taking over greater than it might chew with out actually wanting over the information. It may need been overvalued earlier than – however the P/E calculated proper now at $50 for this yr’s estimated EPS solely provides us 7.26 – so I do not assume it was overvalued at that worth earlier than and it definitely would not be now. I feel that drop within the worth was an enormous overreaction. Not just like the inventory market does not do this every so often.

A fast and soiled valuation technique takes the YoY earnings progress to assist us discover a valuation and it seems to be very undervalued there as properly. The expansion fee from FY18 to projected FY19 is eight% utilizing non-GAAP EPS (6.88/6.36 = 1.08). eight x 6.88 = $55.04/share. It is a fast and soiled technique however finally ends up being shut on small-mid cap shares often.

On the valuation entrance it is also fairly notable that from Oct. 1, 2018, till Dec. 1 2018, SGH gained about 20%, whereas the broader market is in correction territory. That might point out a variety of technical power for the inventory.

So that provides us a shopping for alternative proper now at a really engaging worth. It is early in SGH’s maturation as an organization, however the indicators up to now look promising.

The Not-So-Good

They seem to be a Small Firm

I really like small enterprise and small-cap shares, I actually do. However they’re inherently dangerous. We do not know a ton about them but. We do not understand how they will react to booms and busts, how they’ve ready themselves for a recession, or how they will spend their cash once they make it. All of those elements are, to some extent, unknowns in all corporations – however at an all-time excessive in small ones.

They do not have a ton of money available – solely $39m final quarter (though a few of it possible went to Penguin as that they had $64m the quarter prior). This can be a little bit of a difficult state of affairs. They’ve solely a tiny little bit of respiration room right here. They will deal with some small issues however a pair huge ones in a row they usually’ll need to tackle extra debt they usually’ve already acquired lots (see the subsequent part).

Debt

The corporate has fairly a little bit of debt. It is long run debt/fairness is at 98.Four% (supply for his or her stability sheet). Yikes. However that does embrace the cash it paid for Penguin. In comparison with its business with a mean round 50% (supply) it isn’t doing properly on this regard.

It was paying down its lengthy-time period liabilities pretty shortly from 2015 – 2017 (dropped from $235m to $154m), then took on extra this final fiscal yr to pay for Penguin, ending FY 2018 at $184m. It is essential to notice that it was making far much less cash in 2015, but clearly capable of pay down its debt pretty shortly whereas burning money. Based mostly on its prior efficiency I do not assume there’s any cause to fret about paying off that debt.

The remainder of these liabilities are principally accounts payable. It has maintained a stability round $200m since 2015 and does not look like battling it. I am not very snug with the extent that prime – particularly with dangers in overseas foreign money change, however they famous they’re taking steps to fight that by paying all distributors in Brazil as shortly as potential.

The excessive quantity of debt they’re carrying is dangerous provided that they seem to be a small firm simply discovering their legs. I might be extra involved although in the event that they hadn’t made a traditionally concerted effort to pay it off. They clearly perceive the significance of paying it to permit for future enlargement (like Penguin), and for that reality I am not going to rely the full debt load towards them too exhausting.

Gross Margins

Their gross margins are low for semiconductors at 22.6% (supply) and the typical is 55.63% within the business (Q3 2018). This would possibly not permit them to climate all of the storms that they could come up towards. However is it actually an issue for SGH?

Contemplating their enterprise mannequin is fairly closely weighted on service, with manufacturing solely in Brazil, it does not look that dangerous. Most service corporations get loaded down on their COGS and thus have low gross margins. When you begin to take a look at SGH extra like a service firm and fewer like a chip producer the low GM begins to make sense.

Cycle Peak

Proper now we’re seeing semiconductors doubtless coming to a little bit of a peak within the US. They will should rely fairly closely on their Brazilian market within the coming years because the US probably enters a recession. They nonetheless have some extra progress alternative earlier than that hopefully, nevertheless ,in order that they have a while to stockpile money and achieve clients.

Besting the cycle and popping out of the recession intact would be the first true check of this firm’s management mettle. In the event that they steer the corporate in the appropriate path and open up their strains of distribution (like with Penguin) then they will be much better capable of climate the arduous occasions. I really feel the administration could be very ahead wanting on this facet based mostly on that acquisition.

Conclusions

I consider SGH offers a greater than sufficient return for an extended-time period shareholder, nevertheless the security of principal is in query based mostly off a number of easy details:

  • They’re small and the financials mirror it
  • They’ve plenty of debt
  • The US will probably quickly be getting into a recession and small corporations will lag behind

This stuff are mitigated by:

  • A great presence in a overseas, increasing, financial system
  • Unbelievable progress
  • Nice worth at current

Based mostly on this I would not advocate bigger than a three% place in any portfolio, and provided that the investor is prepared to take a medium danger. I personally carry this inventory at a three% place and have an roughly 20-year time horizon.

Disclosure: I’m/we’re lengthy SGH.

I wrote this text myself, and it expresses my very own opinions. I’m not receiving compensation for it (aside from from In search of Alpha). I’ve no enterprise relationship with any firm whose inventory is talked about on this article.

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