SMART Global Holdings Momentum, Room To Move Higher?

SMART Global Holdings NASDAQ: SGH is part of the semiconductor family, a sector that has taken on the spotlight during the past few weeks; the attention to the space was drawn after NVIDIA NASDAQ: NVDA reported optimistic outlooks and bullish results around its artificial intelligence departments.

As demand for chips and semiconductor remains, emphasized by NVIDIA's market and sales expansion, SMART Global is well positioned to keep riding on the momentum its stock has built by merit and association. Luckily for investors in the stock, markets are still placing further potential upside, more importantly, favoring SMART Global over other well-known competitors.

Despite posting some worrying slowdowns across net sales, accompanied by a net loss to investors, management announced a strategic branch sale which may be enough to offset these slowdowns and bring on a new payday for shareholders.

The company's decision to restructure its operations and geographical exposure will be directly accretive, on both a valuation and profitable basis, a dynamic that some analysts may have already been aware of prior to the restructure. Double-digit upside potential, and an industry-preferred spot, come together to offer investors a potential opportunity to ride another wave higher.

Results, Announcement

SMART Global posted a net sales decline of 17.1% compared to a year prior; this is, of course, without accounting for the subsequent inflation effects during the year. Gross margins did improve by an above-expectation 100 basis points, ending the quarter at an attractive 25.7% and still below the full-year 2023 guidance of 26.0%.

The improvements in gross margins, and the expectation for better ones, come from the easing of the underlying industry's supply chains disruptive 2022. Though not the focus of media today, economic surveys such as the ISM nonmanufacturing PMI index hint at a return to normal operations for the industry's suppliers. 

The information industry has been steadily expanding for the past six months, breaking out from its brief contractions. Leading this expansion are supplier deliveries, gaining in efficiency and timeliness, a sign that the underlying bottlenecks in supply chains are effectively improving.

As these previous issues begin to subside, pricing environments will naturally return to their normalized ranges, boosting underlying operator's - like SMART Global - sales and gross margins. Despite these improvements in the underlying ecosystem, the slowdown in sales was enough to bring the company into net loss territory of negative $0.50 per share.

Why would shares advance by as much as 8.4% in the after-market hours of Thursday evening if the company delivered such disappointing results, digging investors into a steep loss that may have to eventually be funded by taking on debt - or worse yet, issuing common stock -? During the company's press release, SMART Global CEO Mark Adams commented, "... With the announced agreement to sell an 81% interest in SMART Brazil on June 13, we are continuing our transformation to a high-performance, high-availability enterprise solutions company...". What exactly are the expected effects of this strategic sale for the future of the stock?

Perception is All

Considering that SMART Global stock is trading at a 70.0x price-to-earnings ratio, one of the highest in the semiconductor industry, it may be a window into broader market expectations for its performance. Other names like Micron Technology NASDAQ: MU, who recently announced their own set of quarterly results, are valued below

SMART Global at a 46.2x P/E ratio. Some may argue that this dynamic only makes SMART Global the more expensive alternative in the space. However, this may be understood as a broader willingness to overpay for every dollar of current - and future - earnings of the underlying. Why are markets valuing these earnings so highly?

The 81% sale of SMART Brazil, at the valuations agreed upon by underwriters, means a windfall of approximately $138 million, with a subsequent payment schedule of $28 million to be delivered 18 months after the sale. Subsequently, SMART Global will retain 19% of the company via options exercisable between 2027 and 2029.

These options will be valued at a strike price equal to 7.5x net income from the closest sale fiscal year, lining up another significant payday for investors. Management states that this sale will be immediately accretive to gross margins and earnings per share, as an adjusted basis can reflect the initial payout and boost valuations significantly.