Aehr Test Systems: Bottomed Out - Strong Buy

Summary

City that never sleeps, Hong Kong

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Investment Thesis

Aehr Test Systems (NASDAQ:AEHR) had one of the toughest six months, in spite of beating the top and bottom lines this quarter and wrapping up 2HFY24 with solid results. The reason is pretty straightforward: Aehr is highly exposed to the automotive correction taking place at the moment and the subsequent slowdown in silicon carbide demand. I think the stock's pullback creates the ideal investment opportunity for bottom-fishers.

In my opinion, and management's opinion, the SiC slowdown is a temporary hiccup due to the auto-correction rather than a longer-term signifier of the SiC growth trajectory. The automotive and industrial correction cycle should end in 1H24, according to my research covering the exposed peer group, particularly power and analog names. A serious pick up in order rates should follow post-correction, and I expect this, combined with increased demand for wafer level test

I believe Aehr is better positioned to outperform in the second half of the year after the FY24 outlook and stock have been de-risked. I would advise longer-term investors to explore entry points at current levels as I see Aehr outperforming the S&P 500 and consensus expectations in 1H25.

Aehr's Value Proposition

Aehr's business is simple and well positioned within the semiconductor industry for mid-to-long-term outperformance, in my opinion. The company provides test systems for burning-in and testing "logic, optical and memory integrated circuits" and has benefited from the increased capacity and test requirement needs in the automotive and mobility integrated circuit markets. This quarter, the company reported revenue up 44.6% to $21.43M and non-GAAP EPS of $0.23, beating by $0.54M and $0.04, respectively. The stock's massive pullback of over 20% post-earnings was the result of management reducing FY24 guidance to the range of $75M-$85M from previous guidance for total revenue to be "at least $100M, representing growth of over 50% year-over-year." Management is still guiding for a 15-3 growth rate %, but investors took the letdown out on the stock. The details are shown in the table below.

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Aehr Test Systems Guidance

The revised guidance is due to customer uncertainty weighing on orders due to the current auto-correction. ON Semiconductor (ON), Aehr's largest customer, accounting for ~88% of its revenue in 1Q24, reported a slowdown in SiC demand late last year due to an auto-correction impacting EVs. Investors new to the semi-industry may ask what SiC demand has to do with EVs, and the answer is simple. The SiC market is estimated to grow at a CAGR of 22.7%, which is supported by heightened EV adoption, as "70 percent of SiC demand is expected to come from EVs." So, it's not entirely surprising that Aehr's stock has been in free-fall since the peer group confirmed the auto and industrial inventory correction in the second half of last year. My optimistic view about the stock is based on my belief that the long end of the correction is already complete; ON Semiconductor, Analog Devices (ADI), Monolithic Power Systems (MPWR), Tesla (TSLA) and others in the peer group already confirmed the slowdown and guided conservatively. I think we're in the darkest hour before the dawn for Aehr and see order rates recovering in the second half.

Product revenues account for the bulk of Aehr's revenue at 92.6% of total revenues, while services (currently the company's fastest-growing segment, up 97% Y/Y) account for 7.4%. For the sake of comparison, in a year ago quarter, Aehr's product revenue accounted for 94.5% and services for 5.5%,, as shown in the chart below. I speculate that services will be in the double-digit range of total revenue by early FY25.

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Aehr Test Systems 10Q

The Bottom is Out

I don't expect the turnaround moment to be in the April quarter, but I believe we've already hit the bottom for Aehr's stock. In other words, I think the worst is priced into the stock price and outlook. Aehr stock is down ~56% over the past twelve months, underperforming the S&P 500 by 88%, as shown in the graph below.

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SeekingAlpha - YCharts

The major pullback was in October of last year when the market woke up to the cyclical downturn in the EV industry. The downturn is better reflected, or priced into, the stock's six-month chart against the S&P 500, during which Aehr underperforms the S&P 500 by 86%, as outlined below.

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SeekingAlpha - YCharts

Shifting to Aehr's three-month performance, a similar downward trend continues to play out. The stock is down 48% over the past three months compared to the S&P 500 down 10% over the same period. The graph below better highlights the three-month sell-off.

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SeekingAlpha - YCharts

I believe Aehr stock has bottomed and the negative has been priced in at current levels. Thus, now I think the stock is better positioned to outperform its own conservative guidance in the second half of the year.

What about the Valuation

Aehr is not cheap, but for the growth potential in the SiC business, I wouldn't say it's expensive. The stock is trading at a Price/Earnings of 36.0, compared to the sector's 27.7. The stock's Price/Sales is 8.8 also above the sector average, as shown in the chart. I understand investors' concern over the higher valuation, but I believe the risk-reward for Aehr remains favorable despite it, as I consider Aehr a growth stock.

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Jefferies Group

What Could Go Wrong?

In my opinion, Aehr's greatest threat at the moment comes from the concentration of its revenue by geography in China, as shown in the chart below. Asia made up ~88.3% of total revenues this quarter, as shown in the chart below. In this quarter's 10Q, management stated that "international revenues significantly increased, compared to the same periods in the prior year, primarily as a result of the shipments to our customers in Asia and Europe, partially offset by the decline in net revenue from a customer in the United States." Now, the slowdown in China and from Aehr's largest customer has been priced into the stock, but there remains a risk if orders don't pick up in the post-correction environment.

I think there will be a brief lull before order rates recover meaningfully, but I believe it is a question of when rather than if. So, the worst-case scenario I see playing out here is if the post-correction volume recovery takes longer than anticipated, in which case we'd see auto-related demand recover in 1H25. In my opinion, this is unlikely as it would mean prolonged muted demand in the EV market, which would cause an industry-wide reset.

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Aehr Test Systems 10Q

What's Next?

In my opinion, Aehr is an under-the-radar growth stock that'll outperform in the post-correction environment. I believe the weakness is already priced into the stock and management's FY24 guidance, so investors jumping in now are jumping in at the bottom. Aehr is uniquely positioned with On Semiconductor, so I think there is a correlation between On Semiconductor's anticipated rebound in the second half of the year and Aehr. I think Aehr will outperform consensus and the peer group in 2025.