Emerging Memory Tech Demand Will Create Opportunities Amid Risks From DRAM Dependency And Margin Pressures

Key Takeaways

• FormFactor's leadership and diversified portfolio in DRAM and advanced memory techs are expected to boost revenue and market share.
  
• Strategic diversification in emerging techs and partnerships reduces dependency on volatile segments, supporting profitability and new revenue streams.
  
• Reliance on DRAM and high customer concentration pose revenue risks amid geopolitical tensions, while quality costs affect margins negatively.

Catalysts

Designs, manufactures, and sells probe cards, analytical probes, probe stations, metrology systems, thermal systems, and cryogenic systems to semiconductor companies and scientific institutions.

• Record demand for DRAM probe cards, particularly from DDR5 and high-bandwidth memory (HBM), positions FormFactor to capitalize on growing demand in advanced memory technologies. This should boost future revenues.
  
• FormFactor's leadership in DRAM and its exposure to industry trends like generative AI through its diversified product portfolio are expected to enhance market share and drive revenue growth.
  
• The transition to HBM4 and the increasing complexity and test intensity associated with advanced packaging increase the demand for FormFactor's specialized probe cards, supporting future revenue and profitability improvements.
  
• Strategic diversification efforts in the foundry and logic markets, including new customer qualifications and product enhancements, are aimed at reducing dependency on volatile segments and improving net margins through a balanced opportunity profile.
  
• The growth potential in co-packaged optics and FormFactor’s partnerships for high-volume production equipment position the company well for new revenue streams in emerging technologies like data center applications, which could positively impact future earnings.

FormFactor Future Earnings and Revenue Growth

Assumptions

• Analysts are assuming FormFactor's revenue will grow by 8.2% annually over the next 3 years.
• Analysts assume that profit margins will shrink from 18.3% today to 13.9% in 3 years time.
• Analysts expect earnings to reach $131.0 million (and earnings per share of $1.44) by about December 2027, down from $135.8 million today. However, there is a considerable amount of disagreement amongst the analysts with the most bullish expecting $152.8 million in earnings, and the most bearish expecting $113.4 million.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 46.3x on those 2027 earnings, up from 25.0x today. This future PE is greater than the current PE for the US Semiconductor industry at 31.9x.
• Analysts expect the number of shares outstanding to grow by 5.43% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 7.94%, as per the Simply Wall St company report.

FormFactor Future Earnings Per Share Growth

Risks

• The reliance on DRAM probe-card sales, which currently make up a significant portion of revenue, presents a risk. Any downturn in DRAM demand could adversely affect revenue and gross margins, as a more balanced product mix is necessary to reach higher margins.
  
• A reduction in foundry and logic demand, particularly in high-volume end markets like mobile handsets and client PCs, could negatively impact revenue and profitability, as these areas have shown weakness.
  
• The company's dependence on a single major customer for HBM contributes to revenue concentration risk. Any shift in market share or purchasing behavior by this customer could significantly affect revenue stability.
  
• Gross margins were adversely affected by less favorable product mixes and unexpected quality-related costs in the Systems segment. Continued or increased quality issues could further impact net margins.
  
• Geopolitical tensions, particularly between the US and China, could affect FormFactor's ability to conduct business in China, leading to potential revenue declines from a significantly contributing region.

Valuation

• The analysts have a consensus price target of $53.56 for FormFactor based on their expectations of its future earnings growth, profit margins and other risk factors. However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $65.0, and the most bearish reporting a price target of just $44.0.
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2027, revenues will be $941.3 million, earnings will come to $131.0 million, and it would be trading on a PE ratio of 46.3x, assuming you use a discount rate of 7.9%.
• Given the current share price of $43.87, the analyst's price target of $53.56 is 18.1% higher. Despite analysts expecting the underlying buisness to decline, they seem to believe it's more valuable than what the market thinks.
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.