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Last summer, I concluded that shares… vision techniquesNew York Stock Exchange: Keys) They were getting into my sight. Shares fell to their lowest levels in 52 weeks as results were lower than expectations, amid a decline in the volume of orders.
fast Nearly a year later, Keysight continues to struggle with poor order intake, which is hurting sales and margins as well. Amid the interesting deal announced recently, I remain bullish on Keysight in the long term, although a return to growth would be very welcome.
Keysight – Connecting and securing the world
Keysight is a $5.4 billion company aiming to accelerate innovation to secure and connect the world. The company reports results across three segments, with business communications accounting for nearly half of sales. This is complemented by a 30% contribution from the electronics industry sector, with the remainder of sales coming from Aviation, defense and space markets.
The company provides a huge and diverse range of products including oscilloscopes, analyzers, meters, software, wireless products, generators, standard instruments, networking and testing equipment, among others.
In terms of geographic exposure, about 40% of sales are generated in the Americas, as well as Asia Pacific, with Europe accounting for about one-sixth of total sales. The company employs approximately 15,000 workers, serving more than 30,000 customers in more than 100 countries worldwide.
The company is in good standing and a profitable business. The company records operating margins of approximately 30% of sales as the company has seen a very strong rise over the past decade. Over the past eight years, the company has essentially doubled its sales while increasing operating margins from the teens to the high 20s. All of this has tripled earnings per share to about $7.50 per share.
This resulted in significant gains for shareholders after the company was demerged Agilent (A) Back in 2014, at that time the stock was $30. Shares peaked at around $200 in late 2021, but since then, shares have mostly traded in a price range of $125 to $175.
Pick up the case
In November 2022, the company announced its results for fiscal 2022. Revenue rose 10% to $5.42 billion, with adjusted earnings reported at $7.63 per share. After adjusting for stock-based compensation expense, earnings were about $7 per share. Orders were reported to have increased 10% to $5.98 billion, adding to the unidentified backlog.
While revenues grew in the first quarter of 2023, order reception was in the opposite direction, with book-to-bill ratios coming in at less than once. The company announced the €913 million acquisition of France-based ESI Group in early summer, acquiring the provider of virtual prototyping solutions in the automotive and aerospace markets. With a revenue figure of just €140 million, a sales multiple of 6.5 times was somewhat demanding.
The real shock came in August, as third-quarter sales remained flat at $1.38 billion, yet order volume fell 15% to $1.24 billion, weighing on near-term sales expectations. At $129, Keysight received a $23 billion equity valuation, as the company operated with a largely flat net cash position (accounting for the ESI deal). With ESI adding about 2% to pro forma sales, a leverage-free balance sheet, and shares trading at a realistic earnings multiple of 17 times, I liked Keysight’s prospects here, backed by a solid track record as well.
recession
Since last summer, shares have already shown a rapid recovery of about 25% to $160 per share by the end of the year, with shares still trading at those levels in May. In recent weeks, shares have fallen to $135 per share, mostly tied to weak second-quarter results.
In November of last year, Keysight reported 2023 sales of $5.46 billion, up less than 1% from the previous year, as total full-year orders fell 13% to $5.19 billion. The company was able to increase adjusted earnings from $7.63 per share to $8.33 per share, and after backing out pre-tax stock-based compensation expense of $0.76 per share, I peg realistic earnings at approximately $7.75 per share.
The company reported a net cash position of about three-quarters of a billion dollars, but is still ahead of the deal with ESI. The company only set Q1 guidance, but with revenue seen at the midpoint of $1.245 billion, that wasn’t very inspiring.
ESI’s tender deal gave Keysight a stake of more than 98% of ESI’s shares as announced in January, so some bright news could be welcomed. After all, Keysight reported a roughly 10% decline in first-quarter sales to $1.26 billion, with orders falling even further to $1.22 billion. This really impacted the results on the bottom line as well, with adjusted earnings falling from $2.02 per share to $1.63 per share. Furthermore, Keysight expects second-quarter revenue to reach just $1.20 billion, with demand remaining weak.
In May, Keysight reported second-quarter sales of $1.22 billion, just ahead of guidance, but still down more than 12% year over year. Order volume of $1.22 billion was nearly equal to the lower revenue base, marking the first time in a long time that the book-to-bill ratio exceeded 1. With adjusted earnings reported at just $1.41 per share, the adjusted earnings trend is at just $6 per share.
The company does not expect an imminent rebound, guiding third-quarter sales at a midpoint of $1.19 billion.
Another deal
With 175 million Keysight shares worth $23 billion and a variable market cap, and a similar enterprise value amid a flat net debt load, the company is engaging in mergers and acquisitions (again) in order to stimulate growth.
In March, the company made a 199 pence-per-share offer for UK-based Spirent in a deal valued at $1.46 billion, in a deal equivalent to about 6% of the company’s market capitalization here. Through this deal, Keysight will add automated testing and assurance solutions for networking and cybersecurity, among others.
The pro forma net debt load of $1.5 billion is perfectly manageable given Keysight’s still strong earnings power. The deal is very interesting given that Spirent is a large company with close to half a billion in sales, which adds about 10% to pro forma sales, although these sales are down significantly in 2023, and the same is true for margins.
What now?
The reality is that the strength of the current gains will be completely weakened. The company could be lucky if adjusted earnings reach $6 per share this year, which would put realistic earnings at just $5.50 per share if we exclude stock-based compensation expense. This takes the valuation from about 18 times market multiple to about 25 times earnings, due to a tougher year.
The truth is that the current weakness is taking too long for me, as it seems that some implementation issues may be at play here as well. The reality is that we’re seeing similar trends in more companies here, so we can’t be too harsh on Keysight here.
The long-term thesis doesn’t look weak, as I expect a real earnings rebound in 2024. Furthermore, Spirent’s latest deal looks very compelling, with the company able to effectively use its balance sheet to buy a somewhat challenged peer at a very reasonable price. Multiple attractive sales.
In the midst of all this, I’m still pretty passive when it comes to stocks, and after I bought a small $120 stake in the summer of last year, stock trading has been pretty stagnant. Clearly, the recovery will take longer than expected, but stocks still look compelling given the long-term promise.
