Elmos Semiconductors (XTER:ELG, Financial) is a technology company that belongs to the industry of broad line semiconductors.
Core competence of the company includes mixed signal ICs. Elmos offers more than 140 application-specific semiconductors, or ASSPs. The company is also involved in the provision of microelectronic mechanical systems, or MEMS.
Elmos mainly serves the electronic segment of the automotive markets. Competitors of the company include Infineon Technologies (XTER:IFX, Financial), Melexis (XBRU:MELE, Financial), ON Semiconductor (ON, Financial) and STMicroelectronics (STM, Financial). Elmos Semiconductor AG was founded in 1984 and is headquartered in Dortmund, Germany.
Revenue classification
Source: Elmos Annual Report 2016
Elmos Semiconductor AG generates more than 90% of its revenue from the semiconductor industry and the remaining of its revenue is contributed by micro-electromechanical systems, or MEMS. As a semiconductor manufacturer specialized in automotive application, 85% of Elmos’ revenue comes from automotive industry. Industrial, consumer good and medical technology industry contribute for the remainder of about 15%.
*Includes industrial and consumer goods industry as well as in medical technology
Geographically, Asia Pacific contributed 35.2%, or 80.5 million, toward the total revenue during the fiscal year 2016. Europe was responsible for 53.6% of the revenue share of the company during 2016. The revenue distribution is concentrated as top 10 customers contributed 65% toward the revenue during 2016.
Industry prospects
As car safety awareness increases, the sensors market will take off. Temperature and car pressure monitoring, advance driver assistance systems and safety alert systems are becoming relevant, leading to an increase in electronic content in vehicles.
German Electrical and Electronic Manufacturers' Association, the ZVEI, anticipates annual average growth of about 4.5% for the global automotive semiconductor market in the period from 2016 to 2020. ZVEI believes that demand for connected cars, which is set to quadruple by 2012, will contribute to the growth of the automotive electronic market. The association also expects the automotive microelectronic turnover to grow at CAGR of 5.9% during 2014-2020.
Moreover, IC Insights predicts that the automotive electronics system market will grow at a CAGR of 4.9% during the 2015-2020, which is the highest among the electronic system categories. Autonomous vehicles are also expected to fuel the growth of microelectronics; McKinsey forecasts that, by 2030, 15% of all vehicles sold will be fully autonomous.
The automotive power market is expected to grow to $8.5 billion by 2022, translating into a CAGR of 7.5%; IHS expects ADAS growing, the fastest of all the segments, at a CAGR of 16% from 2015 to 2022. However, markets&markets is more optimistic about the advanced driver assistance market and expects it to grow at CAGR of 10.41% during 2016-2021; makets&markets also forecasts a 7.7% CAGR in the automotive sensor market during 2015-2020.
To review, automotive electronics markets is set to grow in high single digits. This growth is supported by the increase of electronic content in vehicles, thanks to the increase in safety awareness and the growth of ADAS. Further, a shift toward autonomous vehicles is set to help the growth of IC content in the automotive industry. Elmos is exposed to the growth of these industry trends as it primarily serves the automotive market in sensors, motor control and embedded solutions.
Thesis
The company is exposed to the growth of automotive electronics. Elmos is the leader in semiconductor manufacturing related to automotive electronics. Elmos produces a wide range of automotive electronics products such as sensor readout ICs and sensor elements; its chips are used by virtually all carmakers worldwide. Therefore, the company is set to benefit from the growth of ADAS and an increase in electronic content per vehicle. Note that the company’s revenue forecast is in line with the industry’s growth forecast, high single-digit growth. In addition to that, the trend for less emission up to electromobility has great potential. Efficiency improvements, for example, with LEDs for the interior and exterior, and the networking of all those systems with each other are important megatrends for Elmos as well. The company will also benefit from increased car safety and environmental protection awareness.
Elmos is exposed to the growing Asia-Pacific market; low penetration in the U.S. market is also an opportunity. According to EV-Volumes, the electric vehicle sales have reached 773,600 units in 2016 and China contributed 45% to it. The Chinese government is focusing on reducing GHG emissions, smog and traffic congestion. Policies are being developed to push NEV adoption to over 10% share in new vehicle sales by 2020. This is in line with Elmos’ strategy and will definitely benefit it as it is expanding in the Asia/Pacific markets.
Increasing gross margin is a positive sign for Elmos. Gross margin of the company increased from 36.7% in the first quarter to 46.4% in the fourth quarter of 2016. 14.8% year-over-year sales growth. Strong fourth-quarter margin was supported by a high sales volume.
Competition is intense and Elmos is relatively a small company. The company competes with industry leaders as Infineon, STMicroelectronics and NXP Semiconductors (NXPI, Financial). All these competitors are large-cap companies with capital at their disposal for intensive R&D. It will be difficult for Elmos to compete with large competitors in R&D given the limitations of capital. Automotive electronics is constantly evolving and being subpar in terms of R&D doesn’t bode well for Elmos. Further, large competitors can compete on price to steal market share from smaller players like Elmos.
Elmos’ earnings expectations are of low quality. The company missed the analyst estimates two out of four times during the last four quarters with negative surprises as big as 91%. Analysts are quite optimistic about the company’s prospects. The optimism stems from the growth of the industry. Firstly, industry growth is not very high; it’s single-digit growth. More importantly, competition shouldn’t be discounted because of industry growth.
Elmos is expensive based on relative PEG and EVA valuations. Elmos trades at a forward price-earnings (P/E) of around 21, which is expensive as compared to peers. Infineon Technologies trades at a forward multiple of 19.2 and NXP trades at a multiple of 14.3. Earnings growth expectations for Elmos also lag behind that of Infineon and NXP. A PEG-based multiple of 10.9 is used to derive Elmos’ valuation, leading to a price of 11.7 euros $12.38), based on consensus earnings data. This is a downside of more than 100% when compared to the current stock price.
| Valuation, in euros | Consensus EPS 2018 | Multiple | Price Target |
| High | 1.1 | 10.9 | 11.7 |
| Low | 1.0 | 10.9 | 10.5 |
Focus Equity Estimates
EVA-based valuation revealed a similar result with a price target of 14.4 euros. The valuation assessment is based on the discounted EVA computation. The calculation assumes a constant P.A. growth rate of 7.5% in earnings during 2017- 2021 and a 1% growth rate in perpetuity. Note that 7.5% growth is plausible as the automotive electronics industry is set to grow in high single digits during the next few years. CAPM is used for calculating the discount rate. No dilution is assumed in outstanding shares and Standard & Poor's 500 is used as a proxy in the CAPM model.
| EVA Valuation, euros in million | Â | Â | Â | Market value added | 56 | Â |
| Â | Â | Â | Â | Invested Capital | 231 | Â |
| Â | Â | Â | Â | Value of the equity | 287 | Â |
| Â | Â | Price Target | 14.4 | Â | ||
Focus Equity Estimates
The valuation sheet reveals that the stock is extremely overvalued both on a P/E and an EVA basis. The overvaluation can be explained by the optimism surrounding the automotive electronic market. However, despite accounting for a reasonable growth rate, valuation fell short of the current trading price.
Final thoughts
Elmos Semiconductors is a sell amid concerns regarding competitions and overly optimistic growth sentiment. Moreover, the stock is overvalued fundamentally, thanks to the market that is ignoring the threat of competition and valuing the stock ahead of its intrinsic value.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
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