Quarterly results fetishism
In the past week, I studied the avalanche of financial quarterly press releases from companies including ASM International (ASMI), Tesla, Meta Platforms, Texas Instruments, and BE Semiconductor Industries (BESI). All of these releases share similar characteristics: as a reader, you must stay focused on the content of the press releases. However, for an investor, it is increasingly important to read between the lines, to understand what is not directly stated. Rather than dwelling on past events, one should look ahead to the potential opportunities that lie beyond the current challenges.
For instance, consider BE Semiconductor Industries (BESI), a prominent player in the semiconductor assembly equipment sector and headquartered in Duiven, the Netherlands. BESI specializes in back-end semiconductor processes, which involve the assembly, packaging, and testing of semiconductor devices after the front-end process of creating silicon wafers and circuits is complete. Their press release included some statements that could be seen as slightly disappointing. For the first quarter of 2024, back-end semiconductor system orders fell short of expectations, and the anticipated rebound in second-quarter orders is now expected to be delayed. These issues appear to stem from a slower-than-expected recovery in the smartphone and electric vehicle (EV) automotive industries, coupled with a "pause in demand" for 2.5D and 3D applications. Here, "3D" refers to three-dimensional configurations where the world's most powerful GPU semiconductors, such as those enabling Nvidia to lead in Artificial Intelligence, are vertically stacked with High-Bandwidth Memory (HBM) chips from manufacturers like Samsung, SK Hynix, or Micron. This vertical stacking, as opposed to horizontal, adds complexity to chip production. Consequently, significant incremental investments are expected in the next upcycle, including the construction of new factories and the expansion of existing ones, to ensure adequate semiconductor production capacity.
Moreover, as every region in the world no longer wants to be dependent on another region for chip supplies, they are now reshoring production to their own region with substantial subsidies. This has led to the construction of more regional factories. This geopolitical shift, coupled with the increased complexity of producing 2.5D and 3D chips, means that billions will be invested in advanced technological production capacity. In the coming years, this should benefit leading semiconductor equipment makers in the front-end (design) sector, such as ASML, ASMI, Applied Materials, and Tokyo Electron, as well as leaders in the back-end (advanced packaging) sector, such as BESI. The risk seems to lean more towards undercapacity rather than overcapacity for the foreseeable future, especially due to recent underinvestment in advanced packaging. Therefore, when reading a financial press release, I look for confirmation of these future trends rather than focusing on past quarter events. Thus, reading between the lines is often more crucial for confirming one’s insights.
In this regard, the same BESI press release also included some very positive highlights, which I will summarize below. First, BESI's gross margin reached 67.2%, versus the 64% that was expected, due to a favorable product mix. Second, revenue growth reflected strength in both 2.5D and 3D AI-related applications, partially offset by continued weakness in the mobile and automotive markets. Third, BESI expects the paused orders for 2.5D and 3D applications to revive in the second quarter of 2024. Fourth, orders for photonics applications continued to be strong in the first quarter of 2024. Fifth, BESI received a follow-on order for their new system for Chip on Wafer on Substrate (CoWoS) applications. Sixth, it shipped a Thermal Compression Bonding (TCB) Next system for evaluation to a second customer and received indications of interest for additional systems from multiple customers. Seventh, BESI anticipates orders for 25-35 hybrid bonding systems in the second quarter of 2024 from multiple customers. Most importantly, it has expanded its R&D investments to prepare for expected growth in advanced packaging from 2025 to 2027.
It is remarkable that many analysts and investors seem overly focused on the short term, often missing the bigger picture of what could be unfolding just around the corner. This is also evident with so-called whisper estimates and whisper guidance. While expectations are to some extent always factored into any share price, the most optimistic—or perhaps most unrealistic—forecasts are often referred to as the "whisper." For a company to positively surprise on earnings, it must not only surpass its own guidance but also the expectations of analysts, and if possible, exceed the whisper estimate and the anticipated whisper guidance for the next quarter. Very often, even when a company meets its own guidance and normal expectations, the share price may still decline in the aftermath if the report falls short of the whisper. As a strategy, it seems far more important to identify tomorrow’s long-term innovative winners early than to precisely predict the correct quarterly profit figure or judge an achievement based on meeting or missing someone’s whisper number.
This week, we have witnessed significant price swings following quarterly results, which, in my humble opinion, are exaggerated in both upward and downward directions. The focus of the investment case should be on meeting mid- and long-term investment catalysts, not merely on beating or missing a whisper number. It is more crucial to identify tomorrow's innovative leaders by considering their earnings and free cash flow potential for the entire next upcycle, rather than fixating on a single quarter. After all, that quarter reflects just three months in the past and may or may not have met the whisper expectations of analysts and investors.