Company Profile

Canada-based Photon Control Inc (TSX: PHO) is an Electronics & Electrical Equipment company. The company is engaged in designing, manufacturing, and distribution of 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. 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 sells its products globally; however, the majority of the company's revenue comes from the United States (63% revenue in FY19), and rest from the Asian markets. In 2018, the company transitioned from TSXV to TSX.

Investment Rationale

• Strong Balance Sheet: The company's asset to equity ratio at the end of March 2020 stood at 1.28, which implies that the majority of its assets standing in the balance sheet are funded by equity. Further, the company has negligible debt in its balance sheet, with long-term debt/ total capital ratio stood 2%, reflects that most of the growth has been funded by the company's ability to generate high positive free cash flows.

• Free Cash Flow Yield of 7.5%, A Higher Margin of Safety: Free cash flow is surplus cash, which a company is able to generate after meeting its capital expenditure and working capital requirements. PHO’s free cash flow yield stood at 7.5% which is significantly higher, despite a strong rally in its shares over the past one year and primarily in the past three months. The higher free cash flow generation ability of the company reflects the strong financial health of the business and its ability to manage the operations regardless of the economic cycle. Further, free cash flow yield of the company is much higher as compared to Canada 10-year bond yield of 0.53%.

• Robust demand for the group’s product: 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 revolutionized all aspects of the modern economy and lives. Among the technologies driven by semiconductors are smartphones, 5G mobile, the cloud, autonomous driving, and artificial intelligence. As a critical building block of these technologies, semiconductors will continue to enable innovation and transform industries, and hence, chipmakers are expected to increase production to meet this growing market.

• Relative Strength is significantly high: Amid bearish market condition, where a lot of stocks are tumbling and trading far away from their 52W high price level or hitting multiyear lows, PHO's shares have performed completely in the opposite direction. In the last 3-months which broadly covers the COVID-19 led free fall in the market, PHO's shares have soared ~ 109% and significantly outperformed the benchmark index by 67%. Further, PHO's shares are featuring a return of 49% on a YoY basis, 32% on a YTD basis and 18% on a month over the period and outperformed the benchmark index in all the aforementioned periods. This implies a strong relative strength in PHO's shares.

• Oscillating in a Long-run bull cycle: At the last traded price of CAD 1.75 (as on June 17, 2020, before the market close), shares of PHO traded above the long-term as well as short-term crucial price support levels of 200-day, 100-day, 50-day, 30-day and 20-day moving averages, which indicates a bullish price trend in the scrip. Further, the Price/200-day SMA ratio stood at 1.56x, which implies that the last traded price of PHO was approximately 56% above its 200-day SMA, strong bullish trends as higher the positive spread between 200-day and current market price, stronger the trend is. And, moving averages are also enhancing, again a positive trend. 

Q1FY20 Result

In the quarter under consideration, the company's revenue has leapt up by 116% to CAD 17.3 million, driven by an unprecedented surge in the group's performance in all the markets where the group operates. The strong growth in revenue was driven by Asia, where it grew 175% on an annual basis to CAD 9.6 million from CAD 3.5 million. Revenue from the US surged 70% to CAD 7.6 million against CAD 4.5 million in the Q1FY19.

Source: Company filings.

Total revenues for the three months ended March 31, 2020, surged due to an increase in wafer fabrication equipment spending by original equipment manufacturers. Accelerated shipments to customers in response to the COVID-19 pandemic along with revenue from new products further provided support to the top-line. Gross profit stood at CAD 10.6 million with a gross profit margin of 61.2%, up from 52.7% in pcp.  Further, the sales spurt in the Q1FY20 has allowed the company to achieve economies of scale with operating expenses as a percentage of the revenue reducing to ~24% against 43% reported in the same period of the previous financial year. Consequently, operating margin soared to 37.5% from 9.3% in pcp. EBITDA for the quarter ended March 31, 2020, stood at CAD 6.96 million as compared to CAD 1.48 million in the prior comparable period. Net income has also leapt up to CAD 6.6 million for the first quarter ended on March 31^st, 2020, from CAD 0.07 million in the year-over period.

Further, during the period under review, the company has generated a net cash inflow from operating activities of CAD 8.10 million against a net outflow of CAD 2.5 million in the same period of the corresponding financial period. The company's cash and cash equivalents at the end of Q1FY20 stood at CAD 41.2 million, up 10% on a YoY basis.

During the quarter under review, the company has announced that it successfully completed a surveillance audit of its quality management system to maintain the ISO 9001:2015 certification. The company also acquired certain assets of Micronor Inc., a supplier of fibre optic kinetic sensors based in Camarillo, California, USA, for a cash consideration of CAD 844.

Financial Highlights: Q1FY20, Source: Company filings.

Stock Performance

At the time of writing (as on June 17, 2020, before the market close), PHO shares were trading 3.8% lower at CAD 1.75. In a year-over period, its shares have registered a 52W high of CAD 2.02 (as on June 08, 2020) and a 52W Low of CAD 0.65 (as on March 18, 2020). At the last traded prices, shares of PHO traded approximately 170.0% above its 52W low price level and approximately 14% below its 52W high price level, which reflect that shares of PHOs are more tilted towards the 52W high price level, a positive price trend.

1-year price return (as on June 16, 2020, after the market close). Source: Refinitiv (Thomson Reuters)

Top-10 Shareholders

The top 10 shareholders have been highlighted in the table, which together forms around 20.07% of the total shareholding. Mawer Investment Management Ltd. and Franklin Templeton Investments Corporation hold the maximum interests in the company at 10.09% and 5.44%, respectively.

Source: Refinitiv (Thomson Reuters)

Key Risks

Highly concentrated customer base: 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.

Technological change: 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 is likely to lose significant revenue during the lifespan of those products.

Stock Recommendation

The company's performance in the first quarter of FY20 was significantly strong, with a revenue surge of 116% as original equipment manufacturers were spending a lot on wafer fabrication equipment. Further, the demand for the group's products was robust amid COVID-19 pandemic. The group has a robust pipeline as order backlog stood at CAD 30.9 million at the end of Q1FY20, which are likely to be completed in the next six months. Solid order backlogs provide stable revenue visibility, which is positive.

The company has solid fundamentals, with a consistent EBITDA margin above 20% over the past five years, ROE above 10%, negligible debt in the balance sheet and consistent free cash flow generation. Also, despite a strong price performance of the company, it is offering a free cash flow yield of 7.5% which is gigantically higher and reflects the financial health of the business and providing a cushion to the existing and potential shareholders. Moreover, its shares are trading in a strong bullish zone, with last traded price significantly above the long-term and short-term crucial support levels, with 14-day and 9-day Relative Strength Index hovering in a neutral zone. The group is trading at a forward Price to Cash Flow multiple of 4.3x, which is significantly lower than the industry average of 14.7x. 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 current price of CAD 1.75 (as on June 17, 2020, before the market close).

Disclaimer

The advice given by Kalkine Canada Advisory Services Inc. and provided on this website is general information only and it does not take into account your investment objectives, financial situation and the particular needs of any particular person. You should therefore consider whether the advice is appropriate to your investment objectives, financial situation and needs before acting upon it. You should seek advice from a financial adviser, stockbroker or other professional (including taxation and legal advice) as necessary before acting on any advice. Not all investments are appropriate for all people. The website www.kalkine.ca is published by Kalkine Canada Advisory Services Inc. The link to our Terms & Conditions has been provided please go through them. On the date of publishing this report (mentioned on the website), employees and/or associates of Kalkine do not hold positions in any of the stocks covered on the website. These stocks can change any time and readers of the reports should not consider these stocks as advice or recommendations later.