Smart Global Holdings: Keeps Getting The Benefit Of The Doubt Thanks To AI (NASDAQ:SGH)

Smart Global Holdings (NASDAQ:SGH), a designer and supplier of high-performance, high-availability enterprise solutions, needed several months to do it, but SGH has now recouped all the losses its stock suffered after the October 2023 collapse, which saw SGH lose almost half its market value. Furthermore, there is reason to believe the rally has further to go, especially with the stock getting the benefit of the doubt as an artificial intelligence or AI play. Why will be covered next.

The rally continues for SGH

A previous article from last December rated SGH a hold after concluding that even though SGH continues to deal with headwinds, which, among other things, caused the stock price to be sliced in half in October, the stock stood a good chance of revisiting the 52-weeks high of $29.99 due to investor enthusiasm for AI plays.

The promise of AI would trump all else, provided of course SGH could show it is making progress when it comes to AI. Furthermore, expectations for SGH had come down, which created the right conditions for SGH to surprise and surpass market expectations. On the other hand, the article pointed out the risk associated with SGH since the company may not necessarily be a winner in the world of AI, or not as much as hoped for.

The chart above shows how the stock is now well on its way to reaching the 52-weeks high of $29.99 after closing at $26.30 on March 21. Note how if all the lows following the October collapse are connected, an ascending trendline appears, which can be seen as a bullish sign favoring higher stock prices.

Note also how the stock encountered resistance at or near the $23 price level since it took quite a bit of time to get past this level, which is also where SGH found support prior to the October collapse. Recall therefore how the October collapse was the culmination of a decline in the stock that started in June, which saw the stock drop from the June 2023 high of $29.99 to the October 2023 low of $12.66. The 61.8% Fibonacci retracement of this downtrend is $23.37, which helps explain why the stock spent so much time at $23 or so as shown in the previous chart.

The breach of resistance and the backtest that followed paves the way for a return to the 52-weeks high at $29.99. The stock may have to correct first before going higher, because the stock is well into overbought territory after more than doubling since the October low, but SGH looks primed to get back to the 52-weeks high with little else standing in the way.

How solid is the foundation underpinning the rally?

It’s worth noting that while the stock has soared higher in recent months, all is not as well at SGH as some might expect based on how the stock has outperformed. Earnings, for instance, are down. In the most recent report or Q1 FY2024, SGH posted non-GAAP EPS of $0.24 on revenue of $274.2M, both down QoQ and YoY.

The Intelligent Platform Solutions or IPS unit contributed $119M, the Memory Solutions unit contributed $86M and the LED Solutions unit contributed the remaining $70M. In terms of GAAP, SGH ended Q1 FY2024 with a net loss of $11.77M or $0.23 per share. The difference between GAAP and non-GAAP can be mainly attributed to the latter’s exclusion of stock compensation expense of as much as $10.97M.

EBITDA was $34.34M in Q1 FY2024, down from $37.58M in Q4 FY2023 and $57.84M in Q1 FY2023. Note that GAAP EPS in Q4 FY2023 was $1.17, which was the result of a $70M one-time tax benefit. The table below shows how the numbers in Q1 FY2024 compare to the preceding Q4 FY2023 and Q1 FY2023 of a year ago.

Keep in mind that SGH Brazil was divested in November 2023 and the quarterly numbers have been adjusted to account for discontinued operations. Revenue in Q1 FY2023, which preceded the sale, was actually $465.5M, but it turned into $391.8M after excluding the contributions from SGH Brazil. SGH is now a smaller company after the sale, but the sale did bring in an immediate $140M and more down the road.

It’s the main reason why cash, cash equivalents and short-term investments rose to $553.4M at the end of Q1 FY2024, up from $390.8M in the preceding quarter, although this is offset by long-term debt of $748.3M on the balance sheet. Remember that some of the cash is scheduled to be using for ongoing stock buybacks with SGH allocating another $75M to the existing program. The rise in gross margin can be attributed to the divestment of lower margin businesses like SGH Brazil.

(Unit: $1000, except for EPS)
(GAAP)	Q1 FY2024	Q4 FY2023	Q1 FY2023	QoQ	YoY
Net sales	274,247	316,658	391,797	(13.39%)	(30.00%)
Gross margin	30.2%	28.9%	28.6%	130bps	160bps
Operating income (loss)	1,305	(1,639)	14,847	–	(91.21%)
Net income (attributable to SGH)	(11,733)	64,841	(3,939)	–	–
EPS (diluted) from continuing ops	(0.23)	1.17	(0.08)	–	–
EPS (diluted)	(0.38)	(2.54)	0.10	–	–
Weighted-average shares outstanding	52,068K	55,523K	48,962K	(6.22%)	6.34%
(Non-GAAP)
Net sales	274,247	316,658	391,797	(13.39%)	(30.00%)
Gross margin	33.3%	31.7%	31.3%	160bps	200bps
Operating income	26,697	30,295	51,388	(11.88%)	(48.05%)
Net income (attributable to SGH)	12,538	18,406	37,364	(31.88%)	(66.44%)
EPS (diluted)	0.24	0.35	0.75	(31.43%)	(68.00%)
Weighted-average shares outstanding	53,281K	53,290K	49,791K	(0.02%)	7.01%

Click to enlarge

Source: SGH Form 8-K

Guidance calls for Q2 FY2024 revenue of $260-310M, a QoQ increase of 3.9% at the midpoint. The forecast sees a GAAP loss of $0.05-0.25, and non-GAAP EPS of $0.15-0.35, about flat QoQ at the midpoint. Note that the numbers for Q2 FY2023 below are the actual numbers that have not been adjusted for discontinued operations and are provided for reference only.

(GAAP)	Q2 FY2024 (guidance)	Q2 FY2023	YoY (midpoint)
Net sales	$260-310M	$429.2M	(33.60%)
Gross margin	28.5-30.5%	25.7%	380bps
EPS	($0.05-0.25)	($0.55)	–
(Non-GAAP)
Net sales	$260-310M	$429.2M	(33.60%)
Gross margin	31.5-33.5%	28.9%	360bps
EPS	$0.15-0.35	$0.76	(67.11%)

Click to enlarge

SGH is on track to earn between $1.15-1.20 in FY2024, assuming the quarterly numbers get better as the year passes. EPS of $1.18 and the stock priced at $26.90 translates to a non-GAAP P/E ratio of 22x. While this is roughly inline with the median stock, it is more than twice the P/E ratio of 9.7x in the last five years for SGH.

Why SGH gets the benefit of the doubt

While the headline numbers were arguably nothing spectacular, SGH did have another ace up its sleeves. Along with guidance, SGH is calling for 15% or more sequential growth in the IPS unit. From the Q1 FY2024 earnings call:

“Our guidance for the second quarter reflects the following; for IPS, we expect revenues to increase sequentially by 15% or more at the midpoint; for memory, we expect revenues to be approximately flat sequentially at the midpoint as we continue to see certain customers working through finished goods inventories; and for LED, we currently expect revenues to be down in Q2, primarily due to normal seasonality.”

Source: SGH earnings call

Keep in mind that SGH has become an AI play and if SGH is to see growth due to AI, it will appear in the IPS unit. The latest updates from SGH are therefore very encouraging as 15% QoQ growth in the IPS unit is consistent with the premise of SGH as an AI play.

Should someone have reservations about SGH?

However, not everyone is likely to be totally convinced the AI-induced rally is build on a solid foundation. For starters, the IPS unit is more than just AI and it is not clear how much AI is really contributing since SGH does not break down revenue on a more granular level. It is somewhat of a stretch to say AI is driving the IPS unit forward.

In addition, IPS revenue tends to be lumpy in nature, making it prone to QoQ volatility. Recall, for instance, how the IPS unit contracted by 14.9% QoQ in Q4 FY2023, a major reason why the stock collapsed in October. It may therefore be somewhat premature to look too much into a forecast of 15% QoQ increase due to the quarter-to-quarter fluctuations. In other words, while the 15% increase is a positive sign, it is too early to conclude SGH is winning in AI because the evidence is just not there, at least not yet.

True, SGH has done some work for companies like Meta (META), which is expected to be one of the major players in AI, but that does not necessarily mean those companies will go with SGH as they make their move into the world of AI. SGH has the potential to be a serious player in AI, but it has yet to translate that potential into something that can move the bottom line.

Investor takeaways

There is a case to be made in favor of long SGH. The stock managed to punch through resistance and resistance seems to have turned into support. The stock is overbought in the short run, which might cause a temporary pause in the rally, but the stock looks to be heading towards the 52-weeks high at close to $30. The overall trend points to higher stock prices.

SGH is also looking good in terms of what matters more than anything else. SGH seems to be making progress in AI, or at least that is what is implied by the latest results. The market has been willing to ignore all else as long as there are AI-related gains and this could continue, provided SGH continues to show growth in the IPS unit in particular.

However, some may also want to thread carefully with SGH. There is not much hard evidence SGH is benefiting from AI as much as the market thinks it is. The market has been willing to overlook other aspects of the company because its eyes are solely focused on AI, but that could backfire. SGH is arguably not doing as well as one would assume of a stock that has soared higher in recent months. Multiples, for instance, are very elevated because while the stock price has gone up, earnings have not followed along. It is believed AI will drive earnings growth forward, but that has yet to happen. Nor is there a guarantee it will happen.

SGH is scheduled to release its next report/guidance after the market closes on April 9. Until then, there is not much standing in the way of the stock going higher. But if the next guidance disappoints with a slowing IPS unit because the IPS unit tends to be lumpy in nature, a repeat of what happened in October is not out of the question since the market would interpret it as SGH failing short in AI. Keep in mind the stock has rallied since last October, so some sort of correction is probably due.

I am therefore neutral on SGH in light of the above. SGH has rallied in recent months, but the foundation underpinning the rally does not seem very solid. SGH is a risky stock at this point because so much is riding on the perceived benefit from AI. SGH has yet to prove it deserves the label of AI play, yet the market has given it the benefit of the doubt by treating it as one. Sure, the latest guidance shows strong growth in the IPS unit, but that is not enough proof given how lumpy the IPS unit tends to be.

If SGH can show continued AI-related growth, the stock has a chance to rally further. But if SGH disappoints like it did back in October when the IPS unit showed its lumpy character, anyone long at that point could see recent gains evaporate in an instant if the stock loses half its value like it did in October. Thread with caution.