HOYA Offers Appealing Leverage To Long-Term Growth In EUV And Data Center

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Although it has been immoderate clip since I've written connected nan banal for Seeking Alpha, HOYA Corporation (OTCPK:HOCPY) has agelong been 1 of my favourite Japanese companies. Management has agelong been skillful at leveraging nan company's halfway capabilities successful precision solid manufacturing to support commanding stock of semiconductor photomasks, arsenic good arsenic level sheet and difficult thrust substrates, while reinvesting successful diversification into aesculapian devices.

I emotion nan company's leverage to leading-edge spot production, peculiarly masks for EUV lithography (necessary for nan accumulation of nan astir precocious semiconductor designs), and I still spot bully maturation opportunities successful difficult drives. I'm besides intrigued by what sounds for illustration management's willingness to reexamine nan aesculapian instrumentality business pinch an oculus toward improving results aliases narrowing nan attraction of its operations.

Not dissimilar nan business pinch ASML (ASML), nan shaper of EUV lithography equipment, valuation for HOYA is simply a small challenging. While location are immoderate multiples-based approaches that propose upside, and I'm not opposed to nan thought of investing successful nan shares arsenic a valuation-indifferent play connected aggregate maturation drivers, it's not precisely a worth banal and investors tin surely statement its GARP credentials connected nan ground of conscionable really reasonable nan value is.

Hard Drives Drive A Weak December Quarter…

HOYA didn't do severely comparative to expectations for nan December quarter, peculiarly astatine nan profit/margin lines, but nan institution is decidedly suffering from immoderate challenges successful nan difficult thrust market, while maturation successful nan Life Care business remains much unchangeable but little dramatic.

Revenue roseate 1% arsenic reported, but declined 7% successful changeless rate terms.

IT merchandise gross declined 19% arsenic reported and 24% successful changeless currency. While gross from disguise blanks utilized to nutrient semiconductors roseate 17% cc and photomasks roseate 7% (with akin maturation successful level sheet photomasks), income of solid disk substrates utilized to nutrient difficult drives declined 66% cc connected important end-market weakness successful PCs, much mean information halfway capex spending, and inventory guidance decisions connected nan portion of thrust customers.

In nan Life Care business, gross roseate 14% arsenic reported and 5% successful changeless currency. The imagination attraction businesses were solid, pinch eyeglass lenses up 6% cc, interaction lenses up 7% cc, and intraocular lenses up 7% cc, while endoscope gross declined 9% cc. Ceramic bony income improved 12% cc.

Operating net declined 8%, including immoderate uplift from currency, and separator declined astir 3 points to 28.4%. IT profits fell 20% (with separator down 90bp to 47.5%) connected nan diminution successful highly profitable HDD solid substrates, while Life Care profits roseate 10%, pinch separator down 80bp to 21.2%.

… And The EUV Shoe Is Next To Drop

Management sounds comparatively assured that nan extremity is successful show for nan HDD inventory correction. Many players successful nan PC abstraction (including spot companies and PC companies) person expressed their position that nan March 4th will beryllium nan bottommost for nan cycle. HOYA guidance expects different 25% year-over-year diminution successful March, but a betterment thereafter. I don't expect a V-shaped betterment successful nan PC business and I do person immoderate concerns astir request from information halfway customers, arsenic I do judge that information halfway spending will beryllium soft successful 2023 extracurricular of nan hyperscalers.

The bigger rumor for HOYA successful nan adjacent word is nan cyclical accommodation underway successful nan semiconductor industry. While request successful immoderate high-end applications (like information halfway networking) has remained healthy, request from smartphones, PCs, gaming, information halfway processing, communications, and truthful connected has softened. With inventory corrections connected nan way, guidance is expecting a 15% year-over-year diminution successful disguise blank income and a two-quarter correction cycle.

I afloat expect this to beryllium a humble correction, and I expect request to rebound sharply thereafter. TSMC (TSM) has noted that N3/N3E tape-outs person been trending astatine 2x nan complaint of nan anterior N5 cycle, and I expect that will thrust beardown EUV request successful comparatively short order. With astir 80% stock successful nan EUV disguise blank market, HOYA is simply a premier beneficiary of nan ongoing maturation successful nan usage of EUV astatine starring nodes. I'd besides note, though, that Veeco (VECO) is simply a derivative play here, arsenic they supply ion beam etch instrumentality needed to nutrient nan blanks (and they waste to Hoya and AGC (5201.T)).

Multiple Growth Drivers Ahead, But There's Work To Do In Life Care

I'm bullish connected nan maturation prospects successful IT. While I do spot immoderate consequence that EUV disguise blank customers whitethorn look to diversify their proviso guidelines (giving a boost to AGC and Shin-Etsu (OTCPK:SHECY)), I deliberation nan beardown maturation successful EUV and nan upcoming motorboat of precocious numerical aperture EUV (high-NA) will thrust bully momentum successful a business that's already very profitable for HOYA (60% adjusted margins).

I'm likewise bullish connected nan HDD substrate business connected nan different broadside of this correction. There are still opportunities for HOYA to leverage customers switching from aluminum to solid substrates, and likewise still a batch of maturation up successful information halfway investments successful nearline storage. HOYA is besides astir to ramp substrates for drives utilizing heat-assisted magnetic signaling (or HAMR).

I do expect immoderate changes successful nan Life Care business.

The imagination attraction business is fine. HOYA has executed good connected its strategy of targeting maturation successful emerging markets for illustration Brazil and China, arsenic good arsenic successful merchandise invention (like its MiYOSMART lenses for near-sightedness successful young children). The intraocular lens business likewise remains attractive, pinch nan institution leveraging opportunities successful trifocal IOLs and mostly ignoring nan competitory U.S. market.

The endoscope business, though, needs activity and nan CEO has said arsenic much. The institution has mislaid stock to Olympus (OTCPK:OLYMY) complete clip and margins are really alternatively mediocre (low double-digits). I judge a batch of nan issues present person to do pinch going up against nan 800lb gorilla successful nan imaging abstraction and not really moving connected nan therapeutic side. It's reliable to guidelines retired purely connected nan ground of imaging capabilities, and nan much charismatic maturation successful endoscopy is successful therapeutic areas.

HOYA has nan resources to invest/acquire a broader level successful therapeutic endoscopy, but failing that, it whitethorn good make consciousness to retreat from little profitable, much commoditized areas of nan market. The mobility really is astir really overmuch consequence guidance is consenting to return connected successful pursuit of amended maturation and semipermanent profitability. HOYA hasn't traditionally been a risk-taking institution (management usually looks to property their advantages successful existing business and look for adjacent opportunities), and truthful a way that includes much R&D and objective tests whitethorn not beryllium for them, but it would beryllium nan champion opportunity for improving semipermanent maturation here.

The Outlook

To nan grade that high-single-digit gross maturation tin beryllium called a "lull", I do expect a little lull successful HOYA's maturation up of reacceleration successful FY'24 and FY'25 driven by recoveries successful nan HDD, disguise blank, and photomask businesses. Long term, I expect gross maturation to annualize astatine astir 7%, pinch nan Life Care business increasing little vigorously, but still generating reliable profits and free rate flow.

Weakness successful HDD substrates and semiconductor products is impacting near-term profitability, but I expect margins to reaccelerate adjacent twelvemonth and into FY'25, pinch EBITDA margins heading complete 40% and adjusted operating margins accelerating to nan low-to-mid-30%'s. At nan free rate travel line, I expect ongoing leverage arsenic HOYA transitions from FCF margins successful nan low-20%'s to nan mid-20%'s, driving precocious single-digit FCF growth.

Discounted rate travel doesn't propose that HOYA is peculiarly inexpensive now, and likewise it takes a small activity to find a multiples-based attack that drives an charismatic adjacent value. A guardant P/E aggregate of 25x is reasonable fixed really nan marketplace has weighted this institution successful nan past, and pinch nan summation of nan nett rate connected nan equilibrium sheet, that supports a adjacent worth astir 10% to 15% supra today's price.

The Bottom Line

The entreaty of HOYA isn't that it's a inexpensive banal trading astatine an unfair multiple. Rather, it's that it's a much reasonably-priced maturation institution leveraged to above-average maturation imaginable successful EUV-driven semiconductor accumulation and ongoing information halfway maturation (and imaginable further conversion from aluminum to solid HDD substrates), pinch immoderate anticipation of upside from nan Life Care business. I do judge that's a worthwhile opportunity, and this is simply a sanction worthy considering astatine this time.

Editor's Note: This article discusses 1 aliases much securities that do not waste and acquisition connected a awesome U.S. exchange. Please beryllium alert of nan risks associated pinch these stocks.

Stephen Simpson is simply a freelance financial writer and investor. Spent adjacent to 15 years connected nan Street (sell-side, buy-side, equities, bonds); now a semi-retired raccoon rancher. That past portion isn't wholly true. Probably.