EUR 850.00 For Business Accounts Only

Morningstar | AMS Reports Decent Quarter But Near-Term Outlook Looks Uncertain; Lowering FVE to CHF 76

AMS AG reported solid third-quarter results with revenue coming in at the high end of guidance and with earnings exceeding our forecast. However, guidance for fourth quarter was significantly lower than our expectations as well as the market’s, as shares declined by more than 25%. We now believe the firm will miss its long-term revenue growth target while the outlook for achieving management’s margin expansion aims are much less plausible due to underutilization and pricing pressure from major customers (such as Apple). As a result, we are lowering our fair value estimate to CHF 76 from CHF 96. That said, we believe the sell-off is overblown and while near-term pressure will likely mean AMS is unable to achieve its lofty goals, there is plenty of upside with positive signs of revenue diversification. We would encourage risk-averse investors take a close look at the sensor manufacturer at its current depressed valuation, though we reiterate our no-moat rating for AMS which remains extremely dependent on iPhone sales.

Revenue for the quarter was EUR 413 million, a year-over-year increase of 57% and sequential growth of 92%, as the product ramps from Apple and others came online as expected. While better utilization from the firm’s new Singapore plant to support early iPhone sales boosted gross margin to 30.6% (up from 9.5% in the second quarter), management’s outlook for further expansion was limited, in turn weighing on expectations for operating margin expansion in the fourth quarter. The third-quarter operating margin was 7.8%, a 380 basis point increase from a year-ago period while adjusted operating margin increased was 12.6%, roughly flat with the prior-year quarter. While free cash flow remained negative for the quarter at minus EUR 18 million, on account of the sustained investment in VCSEL capacity, cash from operations posted a record EUR 73 million. All in, earnings per share grew by 200% to EUR 0.70, ahead of our prior estimate of EUR 0.40.

Fourth-quarter total sales are expected to increase roughly 10% year over year to EUR 518 million, below our prior expectation of EUR 544 million. We believe the expectation of a more mature product mix indicates that Apple is likely using some of AMS’ previous generation VCSEL products for some of the iPhone lines, leading to lower ASPs than expected for the firm’s products. For the fourth quarter, management expects adjusted operating margin of 18% at the midpoint, a significant decline from the prior year’s 27%. While our prior forecast was for operating margins to decline year over year to 24%, we believe the lower-than-expected guidance indicates that the high-end structured light products that AMS generates may still be a solution in search of a suitable problem. We believe AR through world-facing products remains a significant opportunity but Apple’s seeming ability to make do with older products, along with the AMS’ design wins for cheaper Time-of-Flight products, does make us concerned that underutilization will remain a problem for the near to medium term.

While AMS reiterated management’s long-term CAGR target of 60% between 2016 and 2019, with the expectation of reaching roughly EUR 2.2 billion, we believe that target is becoming less feasible due to the insight that management supplied for the early quarters of 2019. We now estimate the firm will miss this target, coming in closer to 54% over the three-year period with total revenue in 2019 totaling EUR 1.9 billion. Similarly, the firm’s ambitious profitability goal of 30% adjusted operating margin is also looking exceedingly difficult to achieve. In general, we still believe the long-term opportunity in 3D sensing technology is bright for AMS, it has been tarnished somewhat by the firm’s inability to deliver on near-term targets.

AMS remains a leveraged bet on Apple, as we currently estimate roughly 40% of sales are from the latter’s products. However, we are encouraged with the new design wins that AMS announced for two Time-of-Flight wins for Android products. The firm also expects stereo vision 3D sensing products to be released next year and provided positive details on design activity for a world-facing product at a leading smartphone producer. Finally, the announcement of the VCSEL win in robotics is hugely encouraging. A major piece of our thesis on AMS is that robotics and other automation, such as autonomous driving and ADAS, will require sophisticated computer vision hardware and that this is a significant revenue opportunity for the firm. While it remains early stages for these technologies, particularly in the industrial market, these green shoots provide more confidence in our outlook for the firm’s Automotive, Industrial and Medical segment. AMS, recognizing the opportunity in this space and consumer market for optical products, announced that they would “de-emphasize” investment in the environmental sensor market.