Evolving semiconductor industry landscape accelerated by the advent of AI         

The semiconductor industry is rapidly evolving to include higher performance and complex products, necessitating the need for broader and more integrated test solutions. Moreover, the advent of AI has accelerated the need for high-performance semiconductors to power generative AI applications. As demand and complexity increase, the industry will require more sophisticated, advanced tests on a larger scale. Tracking the demand for AI-related applications, the system-on-chip (SoC) tester market is growing and estimated to be around USD3.5bn to USD3.8bn in CY24, while the Memory Tester market is pegged at USD1.7bn to USD1.9bn.

Robust testing market conditions led Advantest to report impressive 2QFY24 performance, driven by better-than-expected product delivery. Sales grew by over 63% YoY to JPY190.5bn, tracking elevated product demand. Segment-wise, Semiconductor & Component Test Systems contributed the bulk of the sales at JPY145.5bn, within which SoC Tester’s sales stood at JPY109.5bn, reflecting YoY growth of over 75%, driven by high-performance computing (HPC) and AI related application products. The sales of Memory Testers increased by over 92% YoY to reach JPY36.0bn, driven by elevated demand for high-performance DRAM, particularly HBM.

Guidance upgrade on the back of strong fundamentals

Riding high on its quarterly performance and better-than-expected sales of SoC Testers, Advantest has revised its FY24 forecast upward to reflect total sales of JPY640.0bn, up from the previous forecast of JPY600.0bn. Sales from SoC Testers are expected to increase over 32% YoY to JPY324bn in FY24, and sales from Memory Testers are expected to surge over 70% YoY to JPY146bn. Additionally, operating income guidance has been raised to JPY165.0bn from the earlier JPY138.0bn, and net income guidance has been increased to JPY122.0bn from JPY105.0bn. However, amid the high demand, the company remains cautious on its 2HFY24 sales owing to its limited supply capabilities, coupled with expectations of a stronger Yen against the U.S. dollar.      

Strong financial position enabling shareholders’ returns

The increased demand for high performance semiconductors for AI has gained traction over the years. This has led to robust tester demand, benefiting Advantest along the way. Sales grew at a CAGR of 11.5% over the period FY18-23 to reach JPY487bn. EBITDA increased by over CAGR 9% during the same period, reaching JPY107.7bn. EBITDA margin increased steadily from 24.7% in FY18 to 33.8% in FY22, however, recorded a decline to 22.1% in FY23 owing to higher SG&A expenses.    

Taking revised upward guidance into consideration and supported by positive macro cues, the management has decided to embark on a share repurchase program of up to JPY50bn (total acquisition of up to 9mn shares) from November 01, 2024, to February 26, 2025. Additionally, the company has declared a dividend of JPY19 per share in 2QFY24, which aligns with the mid-term plan of a minimum payment of JPY30 per share in annual dividends. The company’s planned return program could well be supported by strong cash generation. Free cash flow increased substantially to JPY61.8bn in 2QFY24, compared to cash outflow of JPY0.4bn in 2QFY23, aided by an increase in sales and profitability.

Superior valuation backed by positive sales outlook

Valuation appears to be on the higher side, compared to the historical average and peers. Advantest is currently trading at a P/E ratio of 43.1x (based on 2024 consensus estimated EPS of JPY 195), as compared to its 10-year historical average of 26.7x. The stock is also trading higher than the global peer average of 31.2x. We believe the high valuations can be justified, given the stock’s strong fundamentals, decent free cash flow generation and robust sales.

The share price has outperformed in the recent past, with 1-year returns of over 92% and year-to-date (YTD) returns of over 83%. However, the stock has corrected by around 12% to reach JPY8,815 from its recent high of JPY10,005 made on November 08, 2024. Half of the 16 analysts covering the stock have given a ‘Buy’ consensus rating, with an average target price of JPY9,793, indicating a further upside of over 16% from the current levels. Analysts have consistently upgraded the revenue and EPS estimates for FY24 and FY25 over the past two quarters, echoing the positive sentiments for the company.   

In conclusion, the evolving needs and complexities of the semiconductor industry should bode well for Advantest. The company has already witnessed high tester demand for SoC semiconductors owing to increasing chip complexity. Further, investments and advancements in AI are expected to drive performance improvements in semiconductors and growth in production demand. This in turn is expected to spur demand for semiconductor test equipment products. However, it should be noted that the recovery in demand for testing equipment other than in HPC/AI is expected to remain soft in the near term, giving rise to sales volatility. Moreover, Advantest is also prone to geopolitical risks, muted economic growth and significant competition risks. Nevertheless, the recent correction in stock price has made the company’s valuation attractive, and any further correction could present an enticing investment scenario.