Advantech Earnings: Bookings Seem to Have Bottomed; More Uncertainty From Increasing Investment

We maintain our TWD 361 fair value estimate for narrow-moat Advantech 2395 after the company’s third-quarter bookings rebounded slightly thanks to a recovery in industrial Internet of Things in China. Advantech’s upside is limited, as long-term potential in the retail, energy, industrial, and healthcare sectors is priced in and increased research and development spending may dent profitability in the next two to three years.

The book/bill ratio rebounded by 0.03 point sequentially to 0.82 in the third quarter, with Europe the weakest at 0.63 and North America at 0.77. Amid weak bookings in Europe and North America, we think inventory correction in industrial PCs is at its later stage as Chinese bookings tend to adjust faster. Industrial Internet of Things demand recovery in China propelled that region’s book/bill ratio to 1.01, which we interpret as a sign of cautious recovery in the country’s industrial automation sector. The segment contributes about one fourth of total revenue and yields over 50% gross margin. However, we forecast firmwide gross margin upside to be lacking in 2024 as management said tough competition in China may lead to price cuts.

Advantech’s fourth-quarter guidance is for revenue of TWD 15.2 billion, gross margin of 39.5%, and operating margin of 17% at their midpoints. As these numbers are in line with our expectations, we maintain our earnings forecast for now. Our 2022-27 EPS CAGR estimate remains at 11%, assuming a robust recovery in 2024 and 2025 as Advantech capitalizes on growing automation needs in the retail, energy storage, industrial, and healthcare sectors.

Beyond the next few months, management plans to ramp up research and development expense to 8% of revenue from 2024, reversing a five-year decline. This spending appears aggressive, as it means 2025 R&D expenses will be at least 40% higher than 2023, given our 2022-27 top-line CAGR estimate of 10.4%.