Thesis

Axcelis (NASDAQ: ACLS) is the leading provider of Ion Implant tools, with its Purion line. After suffering from poor earnings revisions trends, concerns over China exposure, and fears of Silicon Carbide supply glut, multiples shrank from Aug-23. We felt this overdone and saw an opportunistic trade to make given the limited downside risk. This investment was in the “Opportunistic” bucket of our investment framework.

Since mid-April, investors have taken a more optimistic view, and LTM P/E expanded from 14x to 20x. With NTM P/E at 23x, above the 5y average of 19.6x, we are taking profits on the position as we do not believe it offers the risk-adjusted return we target.

Entering A Positive Revision Cycle

We published a long article on the company on April 16^th, where you will find more background information.

Since, revisions started bottoming out. F1Q24 Results reported on May 1^st beat expectations. The quantum of beat stabilized. Sales beat by 4%, still below the average of the last twelve quarters, but improving compared to the F4Q23 beat.

Axcelis issued a press release with summary financial results for F2Q24; they will deliver sales 3% above consensus and EPS 6% above consensus. During the analyst day, management provided more color, reiterating the stance that the year would be back-end loaded. F1Q24 results, followed by this pre-announcement, suggest the negative revisions cycle is behind us.

New Long-Term Operating Model (LTOM) targets >$11.50 EPS in 2027

Coming into the analyst day, investors and the sell-side relied on a LTOM unveiled in Dec-21, targeting $1.3bn in Rev and 25% in FCF in 2025. During the Q&A session on this analyst day, management shied away from straightforwardly answering analysts’ questions about reaching that target in time. In my view, management is reluctant to take a stance ahead of possible policy changes impacting demand. For a cyclical business like Axcelis’, it is easier to provide rough long-term estimates than precise short-term ones.

In the 2027 Operating Model, Management:

1. replaced the $1.3bn Rev in 2025 target with $1.6bn in 2027
2. increased Operating Margins (OM) to >27% in 2027 from 26% for 2025
3. left GM targets unchanged
4. replaced the 25% FCF Margin target; instead framing FCF as >75% of EBITDA

Capex averaged 1.5-2% in the last four years, so OM >27% implies EBITDA margin of 28-29%, which would have to be converted at 90% to bridge to the original 25% FCF margin target. Entirely plausible, and management gave themselves more flexibility by removing the specific FCF margin target.

In conclusion, management commits to 11% top-line CAGR in the 2023-2027 timeframe, and 12% EPS CAGR, with potential upside from buy-backs, roughly in-line with what I had. With shares priced at 20x 2023 EPS, these targets seem insufficient to drive returns going forward; investors will need positive surprises.

Investors Anticipate Further Positive Revisions

Since our April 16^th Axcelis NTM P/E increased by 9 turns, going from 15.4x to 23.3x. Investors anticipate the revision cycle turn. The focus should now be on how much is being priced in.

To do so, we leverage our Reverse DCF framework. The inputs are simple: 1) WACC, 2) Perpetuity Growth Rate (after Y10), 3) Next Twelve Months Forward FCF, 4) Current Price. We can solve for the implied FCF growth rate between Y1-10. The purpose of the exercise is to get a rough idea rather than a precise number. Changes to inputs such as the Perpetuity Growth Rate, risk-free rate or equity risk premium would modify the implied FCF growth rate. Today’s price suggests an implied FCF growth rate of 7-8% in the next 10y.

The sensitivity table reveals that to generate >30% from here, at similar WACC, investors should anticipate >10% in FCF growth, which is unlikely in our view. The company is very profitable as is, making it difficult to further optimize the cost structure; for a comparison across the semiconductor production equipment landscape, see here. Sales growth is the main lever of FCF growth. But Axcelis anticipates the SiC Ion Implant WFE – the fastest segment they are exposed to - to grow only 9-10% CAGR in ’23-’29, against 25% CAGR in the SiC end-market. Investors' FCF growth expectations are close to top-line guidance in Axcelis most exciting market. It is difficult to see what catalyst would shift these anticipations significantly higher.

Increasing Fair Value from $128 to $155

On the back of results and new guidance offered at the Investor Day, I revised my forecast upwards. 2027 Rev/GP/OP/EPS increased by 4%/7%/8%/10%. To assess the long-term potential of an investment, I focus on a Fair Value derived from a DCF. With sales growth converging to 3.3% perpetual growth, with 11% WACC and OPM peaking at 31% in Y10, gets me to $155 a share, in the bull park of today’s share price, and up from $128 in April.

To understand the short-term potential return, I simply focus on relative valuation. Applying the 5y average of 20x NTM EPS to 2025 EPS gives me $172, an upside of 16% from the current share price. In April, Axcelis shares traded at a 29% discount to SPX NTM P/E; they now trade at a 3% premium.

For “opportunistic” investments, my investing framework focuses on risk-adjusted return over a defined timeframe; I focus on IRR, and a measure I call “Forward Sharpe”, which is the projected IRR over the annualized volatility. The 3m annualized volatility of Axcelis is 46%. Looking ahead, I have a PT of $172, based on 20x FY25 EPS of $8.6, 16% upside on a 1y out view. Axcelis offers me a forward Sharpe of 0.3 (16%/46%), below what the SPX has historically delivered – 0.5.

Risks

Reliance On China In The Long Term. Since 2019, Axcelis reliance on Chinese semiconductor manufacturer demand has increased. In 2023, 46% of revenue originated from Chinese customers, compared to 31% five years earlier. A shift in the US Export restriction framework from advanced nodes to power devices would impede Axcelis ability to ship to Chinese customers. The upcoming US Presidential election could cause further uncertainty around US Export policy, and impact the share price.

The Next Act After Silicon Carbide. Management has yet to detail their vision of demand drivers beyond Silicon Carbide. They hinted at M&A, which highlights the risk that they see a limit to the Ion Implanter use case, with low growth or declining prospects.

EV Demand. As noted earlier, we think EVs drive 60-80% of SiC demand to the end of the decade. New designs or technologies could reduce EV volumes or SiC content per EV, posing risks to our forecasts. Furthermore, with China driving 35-45% of overall EV SiC demand, and adoption high already, demand could slow down faster than expected.

Conclusion

Axcelis is entering a positive revision cycle. On the analyst day, the company released better than expected results, and a long-term operating model in-line with my expectations. Although my Long-term Fair Value and my Short-term Relative Value prices are moving up slightly, the share price moved much faster.

As a result, Axcelis does not fit my investment framework, focused on delivering better risk-adjusted returns than the index. We downgrade our rating to hold.