The second quarter financials of microchip giant Nvidia were tensely awaited on Wall Street for weeks. The company, which in the past few months has seen its stock price shoot up in response to the hype over artificial intelligence (AI), sprung a pleasant surprise on the market, with higher than expected growth and positive guidance.
Nvidia is benefiting from high demand for the AI components that it produces, and its good financials should have an effect on all the companies in the sector. Among these are two Israeli companies, Nova (TASE: NVMI) and Camtek (TASE: CAMT; Nasdaq: CAMT), which produce inspection systems for semiconductor manufacture.
The share prices of the two companies have benefitted from the positive momentum in the industry. For the year to date, Nova is the stock with the highest return on the Tel Aviv 35 Index list, at 65%, while Camtek, with a rise of 157%, leads the Tel Aviv 125 Index list. Camtek is currently traded at an all-time high, with a market cap of $2.4 billion. Nova is near its peak, and has a market cap of $3.6 billion.
The rises in the share prices of Nova and Camtek actually come at a time when they are reporting declining revenue. Shahar Carmi, a senior analyst at Psagot Investment House, explains that the entire capital equipment sector for the semiconductor industry is weak, after three years of strong growth. "What’s nice about the capital market is that it reacts in advance, and so Nova and Camtek, like the whole semiconductor equipment market, reached a low in late 2022 that priced in weakness in 2023."
But then, the picture changed. "In fact, two things happened that allayed the fears. Investment in this area did decline, but not all that sharply. First of all, China, because of US restrictions, is making unprecedented investment in microprocessors, and moderating the decline in the sector. Secondly, there is the AI story, which at the moment is a matter of future orders. The financials of the two companies show declines, but the market realizes that there are large orders that will be recognized next year, and that in 2024 there will be higher growth than could have been anticipated."
Nova CEO: Shekel depreciation is good for us
Gaby Waisman took over as Nova’s president and CEO in March, replacing Eitan Oppenhaim, who became executive chairman. Asked what in his view explains the momentum in the company’s stock, he responds: "We believe that it’s a combination of investors’ confidence in the company and its potential to continue expanding into new market segments, and investors’ expectations that the market will shortly start growing again. Looking at the ecosystem in which Nova operates, there are initial signs of stabilization and a return to growth among manufacturers and providers."
What are the outstanding trends affecting Nova’s business today?
Waisman: "The main trend is the switch to three-dimensional architecture in every type of microchip, which introduces new complexities into the production processes, and makes necessary new solutions for production control. At the same time, there is also a substantial rise in the number of types of materials, the compounds and alloys used for producing chips, and as a result there are new challenges that necessitate high involvement of process control. Another prominent trend is the leap in production complexity in the area of packaging and advanced packaging, which creates completely new needs in production process control.
"Another thing is generative AI, an additional potential engine, the impact of which we are seeing in a variety of areas, especially in graphics processors and high bandwidth memory."
To what extent is Nova affected by the conflict between the US and China over microchips, and what do you expect to happen?
"Nova has substantial activity in China, like all the companies in the ecosystem in which we operate. The effect of the tension between the powers is felt, but Nova has an advantage because of its wider spread of production centers. Furthermore, there is significant investment in building future advanced microchip production capacity in the US and Europe, by leading manufacturers such as TSMC, Intel, and Samsung. This investment generates further potential revenue for Nova. The conflict is also expediting Chinese investment in building a local ecosystem to support the production industry, and that could be a challenge later on."
How far does the macro environment affect you - the rise in interest rates, inflation, and the shekel’s weakness against the US dollar?
"Since we are a leading exporter, the weakness of the shekel works in our favor, as does the rise in interest rates, since Nova has large cash reserves of over half a billion dollars. Inflation has of course meant rises in the cost of raw materials that we buy, and there is some impact on profitability, but we are managing to balance that out with our business model."
Expanding workforce
Two years ago, Nova set itself a revenue target of $500 million by 2024. It already overtook that in 2022, with revenue of $571 million (the analysts’ estimate for 2023 is $505 million). The next goal is $1 billion revenue, which according to the company will be reached by 2027. In 2021, Nova acquired a German company that took it into chemical metrology. Waisman says that Nova is constantly seeking acquisition opportunities, and that its strategic plan explicitly mentions acquisitions as one of the paths to future growth.
Meanwhile, Nova has been growing rapidly. Between 2021 and 2022, its workforce grew by 44% to 1,177. "This was the outcome of significant growth in the scope of our business," says Waisman. "Last year, the number of employees was unchanged. At present, we are continuing to hire as needed."
Carmi of Psagot says that the two companies are part of the semiconductor industry, which also includes companies that make the machines used to produce microprocessors, such as ASML, Applied Materials, and Tokyo Electron. "On the process control side, KLA (a US company that bought Israel’s Orbotech a few years ago, S. H-V.) is the undisputed leader, after which come niche companies such as Onto Innovation, Nova, and Camtek. All these companies have enjoyed big rises in their share prices. The euphoria in the semiconductor sector in general and in semiconductor production equipment in particular is at its height."
The semiconductor industry is considered cyclical.
"Over the years, there have been periods of over-investment and under-investment. In general, capital equipment companies grow for two to three years, and then there’s a year of decline. But the global SOX index is not so cyclical; it has performed excellently for twenty years. Long-range, the industry has been very attractive, and the elements that propelled it upwards still exist. Nevertheless, there are periods when the price environment is high, and then the risk rises."
Are Nova and Camtek not there yet?
"That’s a hard question. Camtek is currently traded at a p/e ratio of 29 on its performance in 2023, a level that I don’t recall it being traded at, so there is a genuine fear that the price is high. On the other hand, Camtek’s management spoke of a rise in revenue in the direction of $500 million within about three years, meaning average annual growth of 17%, so a p/e ratio of 19 to the end of 2026 no longer seems terribly expensive.
"I also don’t recall Camtek giving a target three years forward, so it would appear that something big is happening in the industry. Something similar is happening at Nova, but, unlike Camtek, it also has a steady component of revenue from services, which moderates the volatility. "
All in all, Carmi concludes, "it seems that, this year, all the stars have lined up for Camtek, and a large part of them for Nova."
Published by Globes, Israel business news - en.globes.co.il - on August 27, 2023.
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