Photon Control Inc (TSX: PHO) is an Electronics & Electrical Equipment company. The company is engaged in designing, manufacturing, and distributes a wide range of optical sensors. These products are used by the world’s largest Wafer Fabrication Equipment manufacturers and end-users in the semiconductor and solid‐state industries. The company is a leader in optical sensor design and manufacturing for the world’s largest semiconductor equipment manufacturers. Photon’s custom fibre optic temperature and position sensors demonstrate world-class accuracy and long-term stability in harsh environments, making them ideal for monitoring and controlling semiconductor manufacturing processes. The group sales products globally to the OEMs in the United States, Asia and Europe.

Revenue Mix

Investment Rationale

• Ample growth opportunities: The company has a strong business model and operating in an industry with robust demand. The group designs, manufactures and distributes a wide range of optical sensors and systems to measure temperature and position for the semiconductor and other high technology industries. Semiconductors have become embedded in nearly every industry. The company is focusing on Etch segment, which is a CAD 12 Billion markets and is expected to grow by 6% in 2021. Further, the company sees a lot of opportunities in the Deposition segment as well, which is a CAD 13 billion markets. 

• Solid Third Quarter Results: The company reported solid third-quarter results, with revenue jumped by 87%, gross profit leapt up by 113%, operating income bolstered by 234%, net income surged by 143%, and basic and diluted EPS zoomed 200%. Photon’s revenues are strongly influenced by the overall capital expenditure in the WFE (Wafer Fabrication Equipment) market; the group continue to strive to get its sensors onto new process tools from the leading OEMs in order to further grow the market share.

• Better than Industry Margin Profile: The company reported industry-leading margin profile in the third quarter of 2020, with EBITDA margin reported at 39.1% vs industry median of 13.1%, Operating margin of 7.1% vs industry median of 7.1%, and Net Margin of 22.1% against industry medina of 3.6%. Further, the company reported a Return on Equity (ROE) of 5.9% whereas industry median stood at 2.1%, reflects that the company is generating a higher return for its shareholders as compared to the peers.

Source: Refinitiv (Thomson Reuters), Kalkine Group

• Insiders are Net Buyer in 2020: Throughout 2020, the insiders have increased their stake six times. Recently, on November 09, 2002, President/CEO of Photon Control Inc, Nigel David Hunton increased his stake in the company at a price of CAD 1.31, which implies that management is quite bullish on the future performance of the company. Insider’s buying brings a lot of confidence among the shareholders, and it is typically considered a positive signal for a stock’s future performance.

Insider’s Transaction: Source: Refinitiv (Thomson Reuters)

• PHO Shares Recorded Relative Strength in 2020: Share of PHO is ups approximately 54% despite a free fall in the global stock market due to outbreak of COVID-19 pandemic. Further, its shares have reported strong relative outperformance of 55% against the benchmark S&P/TSX Composite and strongly outperformed its peers by 72% over the past one year. Further, PHO is featuring a positive price return in YTD, 3-Month, 1-Month and 5-day trading sessions. The stock outperformed the benchmark and peers on a YoY and YTD basis. This implies a solid relative strength in the stock. 

• Stock Hovering in a Bullish Zone: Share of PHO is hovering in a bull run, with the price hovering above the support levels of 200-day, 100-day, 50-day, 30-day, 20-day, 10-day and 5-day SMAs. Further, Price/200-day SMA ratio stood at 1.14x, implies that stock is trading approximately 14% above its long-term crucial support level of 200-day SMA, a bullish technical indicator 

Technical Price Chart (as on November 17, 2020, after the market close). Source: Refinitiv (Thomson Reuters)

• Risk Associated with Investment: The company's top three customers are accounted for 80% of the total revenue; therefore, the action of even a single customer could have an unfavourable impact on the group's financials. Further, many of its markets are characterized by continuous technological advances, evolving industry standards, shifting customer needs, new product introductions and enhancements, and the periodic introduction of disruptive technology that displaces current technology due to a combination of price, performance and reliability. If its products are not designed into successive generations of its customers' products, the group will lose significant revenues during the lifespan of those products.

Financial Highlights: Q3FY20

Source: Company Filing

• During the three months ended to September 30, 2020, the group’s revenue surged by 87% to CAD 16.33 million. Photon’s revenues were strongly influenced by the overall capital expenditure in the WFE market. Also, the Company reported its second-highest ever revenues of CAD 16.33 for the three months ended September 30, 2020, and net income of CAD 3.60 million.
• Further in the same quarter, the group’s revenue from the United States surged by 104% to CAD 9.73 million and Asia revenue enhanced by 66% to CAD 6.6 million, respectively.

Source: Company Filing.

• Order backlog, defined as the unfilled value of sales orders received or scheduled for the fulfilment, was CAD 27.03 million as of September 30, 2020, a decrease from CAD 29.66 million at June 30, 2020, and an increase from CAD 11.92 million at September 30, 2019. The backlog normalized versus Q2 2020 as we believe customers built excess stock in the first half of the year in response to COVID-19.
• Further, during the quarter under consideration, the company entered into a distribution agreement with Woowon Technology Co., Ltd., a leading Korean distributor.
• Gross profit leapt up by 113% to CAD 10.20 million, and operating income expanded 234% to CAD 5.75 million.
• During the quarter under consideration, the company’s net income improved significantly by 143% to CAD 3.6 million.
• The foreign exchange loss for the quarter was due to the strengthening of the Canadian dollar relative to the US dollar. Conversely, the Canadian dollar weakened relative to the US dollar over the year-to-date period resulting in a foreign exchange gain.

Top-10 Shareholders

The top 10 shareholders have been highlighted in the table, which together forms around 17.56% of the total shareholding. Mawer Investment Management Ltd. and Franklin Templeton Investments Corporation hold the maximum interests in the company at 10.88% and 2.24%, respectively.

Source: Thomson Reuters

Valuation Methodology (Illustrative): EV to Sales based Valuation Metrics

Note: All the forecasted figures are taken from Refinitiv (Thomson Reuters), NTM: Next Twelve Months

Peer Comparison

Source: Refinitiv (Thomson Reuters)

Stock Recommendation: The company has a strong balance sheet with CAD 46.6 million in cash, which can be leveraged to broaden market presence through acquisitions and partnerships. The company is investing in innovation and new product development to serve the customers and expand the markets. The company is expanding into new markets, including energy, industrial, aerospace and transportation.

The company's performance in the third quarter of FY20 was significantly strong with a revenue surge of 87% driven by an increase in wafer fabrication equipment spending by original equipment manufacturers primarily due to the semiconductor cycle. Revenues also increased due to accelerated shipments to customers in response to the COVID-19 pandemic and revenues earned from new products.

Further, the company has built upon strong fundamentals, with a consistent EBITDA margin above 20% over the past five years, ROE above 10%, negligible debt in the balance sheet, consistent free cash flow generation. Further, the company outperformed the industry in terms of margin profile in the latest quarter. Further, the company reported a Return on Equity (ROE) of 5.9% whereas industry median stood at 2.1%, reflects that the company is generating a higher return for its shareholders as compared to the peers.

On the technical front, Share of PHO hovering in a bull run, with the price hovering above all its support levels of 200-day, 100-day, 50-day, 30-day, 20-day, 10-day and 5-day SMAs.

However, the company's top three customers are accounted for 80% of the total revenue; therefore, the action of even a single customer could have an unfavourable impact on the group's financials.

Therefore, based on the above rationale and after considering the aforementioned risk factors in the stock, we have given a "Speculative Buy" recommendation at the closing price of CAD 1.66 on November 17, 2020.

One year daily technical chart. Source: Refinitiv (Thomson Reuters)

*Recommendation is valid at November 18, 2020 price as well.

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Disclaimer

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