Power Integrations: Question Marks Remain Over The Outlook

Summary

• POWI delivered a mixed report, which was soft in several ways, but it also delivered an upbeat outlook calling for better times.
• The current downturn in demand has badly affected POWI, but POWI thinks it can get back to the boom years of FY2020-2022 in relatively short order.
• There are several reasons why POWI may not see a return to previous revenue levels anytime soon worth mentioning.
• POWI was clear as to what to expect, but whether it will be right, or wrong as before, remains to be seen.

Power Integrations, Inc. (NASDAQ:POWI), a supplier of high-voltage power semiconductors, closed the books in FY2023 with the release of the annual report on February 12. In general, FY2023 was a year to forget as POWI struggled with a downturn that turned out to be more severe than anticipated, which caused, among other things, a big decline in fiscal earnings. However, Q1 guidance and the latest outlook are suggesting the worst of the decline in demand has passed. POWI may be on the verge of a recovery, but questions remain. Why will be covered next?

POWI is off to a slow start in 2024

A previous article from last November rated POWI a hold for a number of reasons. For instance, Q4 guidance of $90M in revenue, plus or minus $5M, was a disaster with the consensus expecting a number over 50% higher. Keep in mind POWI had previously suggested the worst of the downturn had passed, but the guidance made it clear that was not correct.

POWI fell short of consensus estimates with Q4 revenue of $89.5M, a decline of $28.3% YoY, but POWI countered it by surpassing EPS estimates with non-GAAP EPS of $0.22, or $0.07 more than expected. However, it's worth mentioning that EPS got a boost from a tax benefit, which added $0.04 to EPS. Reducing the number of shares through buybacks also helped. In Q4 the number was about 680K shares.

In terms of GAAP, POWI recorded GAAP income of $14.3M or $0.25 a share. Note that POWI recorded negative $1M GAAP income from operations, but a $12M income tax benefit and other non-operating income pushed net income into positive territory. The table below shows the numbers for Q4 FY2023.

Source: POWI Form 8-K

If the Q4 numbers are available, then so too are the numbers for the entire year. FY2023 revenue declined by 31.7% YoY to $444.5M and non-GAAP EPS declined by 60.8% YoY to $1.29. POWI finished with cash, cash equivalents, and short-term marketable securities of $311.6M on the balance sheet with no debt.

Source: POWI Form 10-K

Guidance calls for Q1 FY2024 revenue of $85-95M, a decline of 15.3% YoY at the midpoint. It's also flat QoQ with similar margins. Using these guidelines from POWI, Q1 non-GAAP EPS is thus estimated to come in at $0.15, assuming no tax benefits like in Q4 or other gains. Keep in mind POWI is buying shares opportunistically and this could affect the final number.

POWI calls for the bottom in its outlook once again

The numbers in the latest report are nothing to write home about, but POWI also included the following statement in the earnings release, perhaps in an attempt to put a more positive spin on the report. POWI is calling for a return to sequential growth as soon as Q2 FY2024, along with improved gross margins.

"Fourth-quarter revenues declined as expected, and we project first-quarter sales to be about flat sequentially due to continued soft demand and elevated supply-chain inventories. However, channel inventory fell significantly in the fourth quarter, and we expect a further reduction in the first quarter. Based on lower inventories and seasonal patterns we expect sequential revenue growth beginning in the June quarter. We also expect gross margin to rise in the June quarter driven by the dollar/yen exchange rate, higher manufacturing utilization, and end-market mix."

POWI is also optimistic about the outlook further ahead. While POWI acknowledges current market conditions are a challenge, it remains confident it will get back to about $600M in revenue or $150M per quarter, which POWI views as the real quarterly run rate, once the impact of elevated inventories and other temporary distortions are stripped out. POWI believes it could hit the $150M quarterly run rate in H2 2025. From the Q4 earnings call:

"We should be really running at $150 million a quarter. However, it is unlikely, I believe, given the demand situation still being very weak that it will happen in the second half of this year. It'll probably be some time - again, I don't know what 2025 is going to be. But the earliest I can think of that - we're getting there, it'll be in the second half of 2025. And that's just a speculation on my part. It really depends upon demand and inventory levels all coming back to normalcy."

Source: POWI earnings call

What FY2024 could be like for POWI?

Assuming Q1 FY2024 marks the bottom of the downturn, followed by sequential, if slow, growth, which takes quarterly revenue from $90M in Q1 FY2024 to $150M in Q3 FY2025, then FY2024 is likely to end up slightly worse than FY2023 with non-GAAP EPS of $1.15 on revenue of $440M. H2 of FY2024 will be much better than H1, which will carry over into FY2025.

This would give POWI a forward non-GAAP P/E ratio of 63.7x with the stock closing at $73.35 on February 16. In contrast, POWI has a trailing P/E ratio of 56.9x with non-GAAP EPS of $1.29 and a stock price of $73.35. This is well above the average multiple for the last five years, which are 36x and 35x, respectively. The median in the sector is 25x and 23x, respectively.

Is the bottom truly in sight?

Q1 FY2024 is expected to be the trough in the current downturn. However, it is important to note that this is not the first time POWI has called for the trough to be in sight. For example, POWI once called for Q1 FY2023 to be the trough by staying flat compared to Q4 FY2022, similar to Q1 FY2024 and Q4 FY2023, followed by incremental growth. POWI did this as far ago as in the Q3 FY2022 earnings call.

Obviously, POWI was off with its outlook. If POWI got it wrong before, it could be wrong again with its latest take. Furthermore, there is reason to have some reservations about POWI calling for $150M to be the true quarterly run rate. This run rate seems to be based on what POWI did in the years before FY2023 because total revenue in the three years during FY2020-2022 was $1,842M, which averages to a quarterly run rate of just above $150M.

However, these three years witnessed a spike in revenue that was unlike anything in the preceding years. These three years saw the rise of COVID-19 that led to all sorts of consequences like global stimulus, which in turn boosted demand for goods. Companies also kept more inventory on hand due to the elevated risk of supply chain disruptions.

So these three years may not be reflective of the actual state of demand for POWI. The years before FY2020-2022 saw growth that was much less. Annual revenue averaged $423M in the three preceding years or FY2017-2019, well below the $614M in FY2020-2022. In FY2019, the year before COVID-19, revenue was just $421M, which soared to $703M in FY2021. A quarterly run rate of $150M or $600M a year may be too optimistic.

Should POWI be concerned about its exposure to China?

POWI supplies chips that are produced using mature process nodes. It is therefore worth mentioning that China is in the process of ramping up its production capacity for chips using mature nodes, including power chips or the kind of chips that could compete against those from POWI, especially those utilizing gallium nitride.

Source: POWI Form 10-K

Furthermore, China is a large market for POWI, which in theory could lead to share losses for POWI if China goes with local suppliers. The table above shows how China accounted for over half of POWI's revenue in each of the last three years with a share of 59.8%, 54.8%, and 63.6% in FY2023, FY2022, and FY2021, respectively.

There are already complaints from different corners as to what increased chip supply from China could do to upend global markets. POWI with its large exposure to China and its focus on precisely those types of semiconductor chips China looks to ramp up could be in a vulnerable position. This could be another factor that has the potential to derail POWI's ability to get back to a run rate of $150M by next year. In the worst case, China might cause revenue to drop even further than it already has.

Investor takeaways

POWI had a tough year in FY2023 with big declines in the top and the bottom line, but the latest outlook suggests that once we are past Q1 FY2024, the numbers should get better from here on out. The recovery is expected to take POWI back to the heady days of FY2020-2022, before the current downturn, when the quarterly revenue run rate was $150M. This could happen by the second half of 2025.

However, while POWI exhibited confidence in the future, there is reason for doubt. For starters, POWI has been wrong before about the current quarter being the bottom. It is not impossible for POWI to be correct this time, but it should give people pause and ask whether POWI is not being premature calling for the bottom.

It is possible that POWI may not see a return to a $150M run rate as quickly as it anticipates. That level of demand was assisted by an environment that is no longer around. It is difficult to say for sure, but POWI's quarterly run rate based on real demand may be a lot lower than the $150M POWI has targeted.

If this is true, then POWI's earnings potential will have to be adjusted accordingly. POWI is suggesting it can get back to earning $3+ with revenue of $600M+, but it may have difficulty getting past $1.50-2.00 in annual EPS. POWI looks pricey with multiples where they are at current levels and that is before adjusting for lower potential growth.

China is another question mark for POWI. China has been a big market for years, but there is reason to believe POWI can expect stiffer competition in China from local suppliers. Fast chargers, for instance, are one area where POWI is likely to feel the impact of China trying to increase its own production of semiconductor chips that it previously sourced from the outside.

I am thus neutral on POWI. The latest outlook from POWI is an upbeat one, but there are question marks as to how realistic it is. It is not impossible for this outlook to be off, possibly even by a lot. Keep in mind that POWI has been wrong before. Nothing is guaranteed, but if POWI turns out to be wrong again, it won't be for the first time.