Keysight Earnings: Demand Picture Looks Weaker in Coming Quarters; Fair Value to $170 From $175

We trim our fair value estimate for wide-moat Keysight Technologies KEYS to $170 per share, from $175, after fiscal fourth-quarter guidance missed our expectations. The communications market, which is the firm’s largest, and the semiconductor market are exhibiting slower order patterns and customers are pushing out purchases by multiple quarters. These negative dynamics are more than offsetting relative strength in government and automotive markets. Keysight’s good results in fiscal 2023 have been helped in part by working through excess orders left in its backlog, which is now back to normal levels. Management cautions for a few quarters of weakness, and we now expect lower growth in fiscal 2024 behind lower demand. Still, we believe shares are undervalued. An 8% drop in after-hours trading looks like an overreaction to us, and we think savvy long-term investors have a lot to like about Keysight’s competitive positioning, growth profile, and profitability.

Fiscal third-quarter sales of $1.38 billion dropped 1% sequentially and were flat year over year, meeting our expectations. Commercial communications sales are Keysight’s largest driver and dropped 12% year over year. These customers are slowing new spending in response to a soft macroeconomic environment. Government sales and the electronic industrial segment both grew in the double digits year over year, behind stronger spending from defense and automotive customers.

Orders for the quarter dropped 15% year over year and drove the negative stock reaction, in our opinion. Keysight’s semiconductor business is largely manufacturing-focused, and chipmaking customers are slowing demand during a market downturn. Management noted particular weakness out of Asia. We believe lower demand represents delayed spending, not canceled orders, and we expect a rebound to follow. Fiscal fourth-quarter guidance follows third-quarter orders, and $1.3 billion in sales implies a 10% year-over-year decline, and a 6% drop sequentially.