Nova: The Correlation With The Leading AI Play Is Starting To Weigh Heavy (NASDAQ:NVMI)

Nova (NASDAQ:NVMI), a supplier of metrology and process control tools for the semiconductor industry, has lost steam in the last couple of months after an extended rally in the stock. The stock hit a new all-time high as recently as mid-July, but the stock has moved lower lately. This happened in spite of a very strong Q2 FY2024 report, which showed there was much to be much bullish about. The stock actually spiked by almost 20% the day after the Q2 report, yet the weakness in the stock has stuck around. Why will be covered next.

Nova has started to wobble

A previous article from March 2024 mentioned how there was a case to be made in favor of long Nova. The stock, for instance, was in an uptrend with the stock hitting new highs. Yet, the article opted to rate Nova a hold for several reasons, including the fact that the rally was arguably long in the tooth and thus vulnerable to a correction. In addition, much of the growth was driven by China and while this has proven beneficial to Nova, its sustainability was in question.

The chart above shows how the stock continued to hit new highs in the months that followed, the most recent one on July 10 when Nova hit an all-time high of $247.21, only for the rally to stumble from then on. Nova sold off in the latter part of July after a series of blows knocked the stock lower. First, there were reports the U.S. government was considering imposing new restrictions on the export of semiconductor manufacturing equipment to companies in China.

This caused Nova to drop by 13.2% on July 17, which should not come as a surprise due to Nova’s high exposure to the Chinese market. The stock continued to decline in the following weeks due to a sequence of events, including an escalation of tensions in the Middle East and a shakeup in the currency market, especially as it relates to the Japanese yen. The stock market sold off and Nova was dragged along.

However, the stock market rallied in August and Nova was pulled along for the ride. It helped that Nova released a very strong Q2 FY2024 report in August, which sent the stock higher by 19.5% the day after. Nevertheless, Nova was not able to get back to new highs like before, or even to the July 2024 high for that matter. Instead, the stock has started to wobble once more in recent days.

The stock seems to have found support

The recent stumble saw the stock hit a low of $158.00 on August 5. There are a couple of interesting things worth noting here. First, the August 2024 low of $158.00 is close to the April 2024 low of $158.48. On both occasions, the stock behaved similarly. The decline in the stock was halted, and the stock reversed direction to move upwards.

This behavior points to the presence of support. The chart above offers an explanation why. Recall how the most recent or July 2024 peak of $247.21 was the culmination of a long move upwards in the stock that can be traced all the way back to October 2022 when the stock bottomed at $67.40. More significantly, the 50% Fibonacci retracement of $67.40 to $247.21 is $157.31.

This is just below the August 2024 low of $158.00, which could explain why the stock bounced where it did. Buyers stepped in at a support level once the stock got close, and this pushed the stock upwards. This suggests that there are still many out there that are bullish on Nova. If they were not, they would not have stepped in when they did and the stock would not have bounced.

The Q2 FY2024 report has been overshadowed, even though it was a great one

The recent struggles might come as a surprise, especially given how strong Nova has performed until quite recently. Furthermore, the weakness in the stock stands in contrast to the strong results from the company itself. In fact, the most recent report from Nova was not just good, it easily blew past expectations.

The consensus expected non-GAAP EPS of $1.36 on revenue of $146M, but the Q2 FY2024 report showed that Nova earned $1.61, or $0.25 more than expected, on revenue of $156.86M. Both were significantly higher QoQ and YoY, as shown in the table below. Nova finished Q2 F2024 with cash, cash equivalents, bank deposits and marketable securities totaling $537.84M, partially offset by $241.27M of total debt on the balance sheet.

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Source: Nova Q2 FY2024 report

The table above shows a clear progression in the numbers. If that was not enough, guidance was even stronger. Guidance calls for Q3 FY2024 revenue of $168-176M, an increase of 33.5% YoY at the midpoint and non-GAAP EPS of $1.60-1.73, an increase of 35.4% YoY at the midpoint.

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Source: Nova Q2 FY2024 report

Guidance did not extend beyond Q3, but management did say it expected Q4 to be as strong as Q3. From the Q2 earnings call:

“We don’t provide the outlook for the fourth quarter yet, but we do expect it to be as strong as the third quarter.”

Source: Nova earnings call

In addition, management seems to be open to the possibility for further upside. This is bullish, especially since Nova is already outperforming as is.

“looking into the second half of 2024, we see a robust and diversified booking and a potential upside across all three divisions. We see encouraging indicators — so the industry is moving into a growth cycle with strength coming primarily from logic across nodes. We remain vigilant for changes in the market conditions, and confident in our ability to deliver on our promise to outperform the market.”

Nova earned $3.00 in H1 and the midpoint of guidance suggests it will earn another $1.67 in Q3. If we assume Q4 comes in similar to Q3 at $1.67, and it may even come in higher, then FY2024 non-GAAP EPS is estimated to end up at $6.34. This translates to a P/E ratio of 31.5x with the stock at $199.83 as of September 5. In comparison, Nova earned $4.86 in FY2023, which implies EPS growth of 30.4% YoY in FY2024.

Furthermore, Wall Street estimates predict earnings will continue to grow in FY2025. Projections range from $7.17 at the low end to $7.52 at the high end. As a result, the average price target on the Street for Nova is $256.60, well above the current stock price. But in spite of all this, the stock itself has not been able to take advantage. Instead, the stock has struggled, even though Nova has by all means done better than expected.

What is weighing on Nova?

There appears to be something that is weighing on the stock to such an extent that it has overshadowed the strong numbers and guidance from Nova. The chart below offers a possible explanation as to why the stock has struggled lately, in spite of outstanding results from Nova. Note the correlation between Nova and Nvidia (NVDA) in terms of how their stock has traded in recent months.

The chart suggests the reason why the stock has faltered lately is due to what is happening at NVDA. NVDA is still seen at the forefront of the AI wave, and it continues to grow by leaps and bounds because of it, but NVDA has nonetheless not done well lately after a huge rally. NVDA has been weighed down by reports the U.S. government is investigating it for possible violations of antitrust laws.

Furthermore, it is worth mentioning that there are also concerns NVDA may be showing some signs of slowing down. NVDA posted strong results in its latest report and the latest guidance was strong, but not as strong as some seem to have hoped for. Some could see this as a harbinger of what’s to come for other semis that have similarly rallied higher.

These problems at NVDA seem to have spilled over into other companies, including Nova. Keep in mind that the strong growth at NVDA due to AI has caused many investors to look for other stocks that stand to reap the benefits from AI. This NVDA effect has proven to be a boon for many semis, but it appears the opposite is happening. Stocks are getting hit because of problems at NVDA.

Investor takeaways

It is interesting to note how the market has mostly looked past the strong earnings and guidance from Nova. Nova by all means continues to execute well, but the stock has nonetheless sold off lately. Charts suggest Nova is feeling the adverse effects of a close correlation between itself and NVDA in terms of how their stock has traded in recent times.

It used to be that this correlation was beneficial to Nova since NVDA was soaring higher, but the opposite has been the case lately. NVDA is facing several ongoing challenges that have weighed on the stock and Nova has done what it has all year, which is to follow NVDA along for the ride. This time to the downside.

While the issue of trade restrictions has faded into the background lately, it’s worth mentioning that the issue has not really gone away. The U.S. government is still trying to limit the flow of tech and related equipment to China. Nova could be affected by these efforts since China is such a large market for Nova. In FY2023, China contributed 36% of total revenue.

Similarly, tensions in the Middle East remain. Nova is from Israel, which means that the stock is vulnerable to a selloff if there is an escalation in violence. This has already happened before, so it could happen again, especially since tensions in the region have yet to subside. If anything, they seem to be on the rise.

The case to be long Nova has some strong arguments in its favor with the way the stock has performed, recent struggles notwithstanding, and the continued strong growth in earnings, but I am neutral on Nova. NVDA is being investigated, which suggests that the stock will continue to be weighed down in the short term. This will negatively affect other stocks, especially those that trade in close correlation to NVDA. This includes Nova.

While growth has been strong, getting in on that growth comes at a price. Multiples for Nova are significantly higher than most. This can be justified as long as earnings come in strong, something Nova has been able to accomplish, but this growth could take a hit if the U.S. government imposes trade restrictions that limit Nova’s ability to do business with its customers in China.

The stock has been going down in recent weeks, and it may be heading towards the $157-159 region. If the stock gets there, speculators may consider betting on a bounce, since that is exactly what happened the last two times the stock got to the aforementioned region. Support entered the fray at that point, so it may happen again.

Bottom line, Nova is certainly a stock worth keeping an eye on. Nova is growing strongly, but the stock is not without risks. There is after all a reason why the stock has struggled so much in the last few months with everything it has going for it. This is likely to continue in the short term, which suggests it may be better to be standing on the sidelines.