Fresh Aehr

$AEHR, Aehr Test Systems, $CRWD

Upfront, it should be noted Aehr Test Systems is probably among the riskiest companies I've ever reviewed. More on this later, but proceed with extreme caution here. Potential reward is very high, but so is risk. And earnings is tomorrow (as of writing) on 7/13/2023 after the bell, so expect a wild ride.

What does Aehr Do?

Aehr Test Systems has a solution for a major problem in the silicon carbide (SiC) industry. They develop and sell machines that perform reliability screening and stress testing of semiconductors. This testing is crucial, especially in the electric vehicle (EV) market where perfection is required. Aehr's machines can test a whole batch of chips at once, reducing waste and saving costs compared to traditional methods. Their machines are also more affordable and space-efficient. Overall, Aehr Test Systems provides essential machines that improve efficiency and save costs in the production of SiC chips.

Investment Thesis

At a high level, it is a classic story of rapidly improving financials, bolstered by patented solutions within a growing market. The market mentioned is silicon carbide, which I will explain more about next.

About Silicon Carbide (SiC)

It has all the good qualities of regular silicon, plus some extra capabilities that are super useful in power electronics. They enable faster charging, higher power, improved efficiency, compact designs, and longer device lifespan. These advantages make SiC a game-changer in the semiconductor industry, especially for power electronics in electric vehicles. And while we focused mostly on electric vehicles here, enabling faster charging, higher power, etc also would be helpful in other use cases, such as AI.

The SiC market is rapidly growing in the power electronics industry, with early adoption seen in the electric vehicle (EV) sector. SiC offers advantages such as higher voltage and temperature capabilities, leading to benefits for EV manufacturers and consumers. The adoption of SiC chips by Tesla for its Model 3 in 2018 marked a significant milestone for the automotive industry. Experts predict immense growth for the SiC market, with estimates of its chip sales reaching $7.1 billion in 2026, compared to $1.7 billion in 2021. The EV industry's demand for SiC is driving substantial increases in wafer capacity, with estimates projecting a rise from 125,000 wafers in 2021 to 4,000,000 wafers in 2030. The benefits of SiC extend beyond EVs, positively impacting other power electronics markets such as renewable energy and data centers. As the market expands, the growth potential can be further enhanced by adjacent power electronics sectors.

Razor and Blade Model

Aehr Test Systems has a business model similar to the razor and blades model. They sell machines called FOX systems, which are like razors, and these machines require consumables called WaferPak Contactors and DiePak Carriers, which are like blades. The machines and consumables are designed for testing different types of chips on wafers. The machines have a longer lifespan, but the consumables need to be replaced every two to seven years. This creates a recurring revenue cycle as chip technology improves and chip designs change (such as new chip designs coming to market), requiring new consumables. The company expects this recurring revenue to become a significant portion of their annual revenue. By growing their install base and adapting to new chip technologies, Aehr Test Systems aims to increase their recurring revenue.

Management guided consumables to increase to 50% of their revenue over time, up from 45% in 2022 and 35% in 2021. I think it's important to emphasize that, while Aehr does have a recurring revenue model, it is not nearly as recurring as, say, Crowdstrike. Or really any SaaS company for that matter.

Financials

Looking at Aehr's financial data for the past decade, Aehr rarely did more than $7m per quarter. It wasn't until 2021 where they did their first $9m quarter. From there, 2022 continued break neck growth, seeing average quarterly revenues of $15m.

A couple patterns regarding revenue growth: One pattern which sticks out like a sore thumb is that, the company appears to be prone to big drops in revenue in the quarter ending in August (the company's fiscal Q1). Per earnings transcript, the company chalks this up to seasonality. Looking at previous fiscal Q1's shows a clear pattern here.

The other pattern is revenues trending up and to the right - a hallmark of any successful growth stock.

Regarding margin and profits, the company is GAAP profitable and has seen profits of $3.7m and $4.1m in recent quarters. Although this is not much money compared to other companies I follow, the margins achieved are impressive. Its net margin most recently was 24%. Furthermore, gross margins have significantly expanded in recent years. As recently as their fiscal Q1 in 2020, gross margins were as low as 10%. Their most recent fiscal Q1 showed margins of 42%, and their most recent quarter (fiscal Q3) showed margins of 52%.

So in a nutshell, the investment thesis is that the market for silicon carbide is going to more than quadruple within a few years and that Aehr makes the best solution on the market for testing silicon carbide. The company has recurring revenues and has demonstrated rapid revenue, margin, and net income growth, all classic signs of an extraordinary growth stock.

Risks

Worth saying again, it should be noted this is probably among the riskiest companies I've ever reviewed. Some top of mind risks:

High Customer Concentration risk: More than 90% of its revenues comes from just two customers, which is an insane amount of customer concentration risk. There is a very simple reason for this - only a small number of companies are making silicon carbide (SiC) chips for electric vehicles (EVs) in the first place. This means that if those customers decide to change their suppliers or reduce their orders, it could have a major impact on Aehr's revenue.

Competition risk From Existing Semiconductor Equipment Manufacturer/Startup: Big players in the semiconductor industry, like KLA or Lam Research, might enter the SiC testing market. These companies have more resources and a stronger financial base compared to Aehr. If they decide to compete in this market, it could seriously disrupt Aehr's ability to generate revenue.

SiC Market Risk - SiC doesn't reach mass adoption: SiC is considered the future of power electronics, especially for EVs. However, if SiC fails to become widely adopted in the EV industry, it would be bad news for Aehr. Since Aehr primarily focuses on serving this industry, a lack of widespread adoption would severely impact their most important customer base and, as a result, their revenue.

Geopolitical risk: The company "operates sales and service" in Taiwan. In the event China decides to invade Taiwan, this could certainly affect the company's ability to do business.

Portfolio Sizing and Conclusion:

All investors need to weight the risk appropriately for their risk profile. For my own risk profile, my conclusion is that this stock is a no brainer to maintain at least a 3%-5% position in, so long as their business fundamentals continue steady up and to the right, minus some seasonality within reason.

As always, nothing I say is advice. Everything on this blog is for entertainment purposes only.