Just_Super
It would certainly be an understatement to say that Nordic Semiconductor (OTCPK:NRSDY) (OTCPK:NDCVF) (NOD.OL) has had its ups and downs since my last article about the company.
When IoT finally began to realize its long-promised growth potential, sales skyrocketed. from under $300 million to nearly $800 million, driving the share price up more than five-fold, before significant weakness in the end market, particularly in consumer devices, caused the share price to fall more than 75% from its all-time high, with a net gain of around 170% (260% for the local stock). This has seen the shares beat out names like Silicon laboratories (PLATE), Tellink, Synaptics (SYNA), And QUALCOMM (QCOM) (competitors to varying degrees).
With significantly improved recent forecasts and other chip companies like Analog devices (ADI) predicts a bottom in the consumer and industrial markets. I believe the arrow for Nordic Semiconductor is pointing upwards again. If the company can capitalize on continued growth in the IoT space and ultimately return the significant investment in cellular IoT. I believe 10%+ revenue growth is still possible and that the shares represent a reasonable (if riskier) growth investment.
A review of the second quarter results
Although Nordic still saw a significant year-on-year decline in revenue (down 17%), the business at least returned to sequential growth after an admittedly low point. Second-quarter revenue grew about 72% sequentially, a modest 1% increase over sell-side expectations. The Bluetooth business (almost 88% of revenue) saw a 22% decline and a 77% increase year-on-year.
As the company’s largest market, it’s not too surprising that the consumer market is leading the upside, with revenue down less than 2% year-over-year and up more than 60% quarter-over-quarter. The healthcare market remains significantly weak (down 57% year-over-year), but has at least recovered from the trough (up 318% quarter-over-quarter) and year-over-year comps were relatively challenging. Industrial market revenue fell 11% year-over-year (better than what many chipmakers, including Analog Devices, have reported from this category) and improved 59% quarter-over-quarter.
Gross margin was 49.8% on an adjusted basis, down from 53% a year ago, but up 180 basis points from the prior quarter and essentially in line with expectations. EBITDA was down significantly from the prior year period and up nearly $26 million from the prior quarter, following a $23 million loss in the prior quarter, but was nearly $5 million below sell-side expectations.
Growth returns after inventory reduction
Outside of higher-value data center products (accelerators, electro-optics, etc.), few end markets were spared significant inventory issues last year, and Nordic’s IoT connectivity business was no exception. To make matters worse, consumer electronics sales were unexpectedly weak throughout 2023 and into 2024, which not only delayed “right-stocking” of inventory, but also created more uncertainty around customer orders.
This process appears to have worked, and management has seen better demand from Tier 1 customers as well as the broader customer base. While Nordic consistently saw decent (if not healthy) design activity during the downturn, product launches were delayed or came in disappointing quantities. That is now improving, and management’s guidance for Q3 2024 revenue calls for 19% annual growth and 25% sequential growth at the midpoint (and was about 10% above Wall Street expectations).
Silicon Labs is guiding for Q3 revenue to decline about 19% year-over-year and grow 14% sequentially. My take from management’s comments is that there are more interesting design/launch opportunities on the industrial/commercial side of the business (but that’s just my own subjective interpretation).
Relatively speaking, I see Nordic as more sensitive to a recovery in consumer electronics demand – a larger share of Nordic’s business is in areas like mobile/PC, wearables and gaming, and the company is not quite as heavily focused on metering/smart city and AI edge inference. However, I do see some interesting opportunities in the near term for commercial building automation, as well as electronic shelf labeling, although the latter has become quite controversial recently.
Still waiting for the development of cellular IoT
I don’t think Nordic has exhausted its opportunities in near-field IoT connectivity. Applications like patient tracking are still significantly under-used, and there are still significant opportunities in smart home, wearables and gaming, where the company can leverage its 40+ percent share in Bluetooth Low Energy (or BLE).
However, it remains to be seen whether the company can successfully expand its business beyond BLE. The company has built out some features like LTE-M and WiFi, but they are not significant parts of the business. More importantly, the company has invested significant amounts in cellular IoT (about a third of R&D in 2023 versus about 3% of revenue) without much to show for it in terms of revenue.
Cellular IoT is likely to play a big role in Industrial IoT (IIOT), with applications such as asset tracking and monitoring, payment systems, agricultural monitoring, factory automation, etc. It’s not too late, and indeed it took years of investment for Nordic’s BLE efforts to pay off, but attractive Cellular IoT assets are becoming increasingly important as IoT shifts more towards industrial and commercial applications (versus consumer). Likewise, I have some concerns that Nordic is not as well positioned for smart edge devices as some of its competitors, as BLE will not have the “horsepower” to handle many of these applications.
The outlook
Although there is a chance that Nordic will close FY 2024 with flat or slightly positive revenue compared to FY 2023, I expect a modest decline (3%) at this point. However, I expect a significant recovery (around 28%) in FY 2025 and growth of over 20% for the next three years (from 2024). In the long term, I expect growth to slow down, leaving long-term annual revenue at around 10-11%. However, to achieve this, the company will need to expand its core competencies in BLE.
On the margin side, a return to double-digit operating margin is possible next year, but I’m not modeling that. Instead, I expect a mid-double-digit operating margin in fiscal 2026 and a margin above 20% the following year. Long-term, I believe adjusted free cash flow margins can reach low 20% (FCF is adjusted for both capitalized R&D and stock option costs), leading to low double-digit long-term FCF growth.
Both discounted cash flow and margin-driven EV/sales suggest further upside for Nordic from here. Discounted cash flow suggests a fair value in the mid-teens. The EV/sales approach requires a little more “fine-tuning” as I don’t believe margins in FY 2024 or 2025 are representative of what the company can do in a more normal situation. I use a margin in the low 20% of FY 2027, calculate a 3.75x multiple and discount again. Using my FY 2026 estimate (15%) gives me a 2.7x multiple and that drives a fair value closer to today’s price, so there is some risk involved in assuming revenue and margins will rebound.
The conclusion
If you use the last 12 months of results to determine your fair value, you won’t find much here to like. However, I don’t think there are many growth stocks that will work for you if that’s your approach.
Of course, Nordic carries above-average risks – end markets may not perform as strongly, competitors may gain market share, and/or technology may develop in a direction that management does not expect and where the company’s capabilities are not as strong. For investors who can appreciate and accept these risks, this is a name that has recovered from the bottom but still offers upside in a full-fledged recovery scenario.
Editor’s Note: This article discusses one or more securities that are not traded on a major U.S. exchange. Please be aware of the risks associated with these securities.
