This Under-the-Radar Chip Stock Is Up 30% in the Last 12 Months. Is It a Buy?

The chemical element silicon is incredibly important to today's economy. The substance is hard at work right now delivering this page you are reading via the internet, and silicon is in your computer making sure the article is displayed properly for your reading comfort. Silicon is so pervasive in the computing technology world that sometimes semiconductors themselves are simply referred to as "silicon."

But to simply call chips "silicon" is an understatement. As a semiconductive material, silicon can be mixed with other materials to alter its ability to conduct electricity, to withstand wear and tear (like heat), and other properties important to a computing system.

That's where silicon carbide (silicon bonded with carbon, or SiC) comes in. Because of its high voltage and high heat resistance, SiC is an ideal semiconductor for use especially in electric vehicles (EVs) and solar panels -- two growing industries of rising interest to investors.

That's why Wolfspeed (NYSE: WOLF) is our stock under consideration today. An oft-overlooked chip stock that's up over 30% in the last 12 months, the company is a leader in SiC product development and manufacturing. So if EV investing interests you, it pays to know what this company is up to. Let's see if the stock is a buy.

You might have heard of Wolfspeed before

Wolfspeed has actually been around for a while. You might have heard of them under the name Cree, the LED lighting specialist. Last autumn, the company changed its name to Wolfspeed after selling some two-thirds of its business over a multi-year transition period. The last chunk was the sale of its LED segment and the Cree name to SMART Global Holdings in early 2021.

What's left over is a company dedicated to the development of SiC materials technology, as well as gallium nitride (GaN), which has similar properties and uses to SiC and often used in mobile networking gear. Wolfspeed manufactures and sells an extensive range of SiC materials (used in the manufacture of wafers that chips are built on), as well as SiC-based components used in EVs, EV charging stations, 5G network equipment, renewable energy applications, and the like.

This total transformation of its business was prescient. Cree's lighting business was running out of steam, but refocusing on SiC and the applicable markets it serves has turned the emergent Wolfspeed into a high-growth manufacturing outfit.

Revenue surged 42% higher in the recently completed 2022 fiscal year (ended in June) to $746 million, in spite of supply chain constraints that kept a lid on expansion. Wolfspeed expects growth to continue at a robust pace for years to come as SiC market share increases in various industries, from automotive to energy to telecom.

Is this high-growth stock a buy?

With such a high rate of growth and participation in exciting markets like EVs and renewable energy, Wolfspeed stock is surely a buy, right? Maybe, but not so fast.

After narrowing its focus, this company is still very much a work in progress. It's losing money (free cash flow was -$805 million last year). The balance sheet is in great shape thanks to the sales of its former lighting and related businesses in years past -- cash and equivalents were $1.2 billion, offset by convertible debt of $1 billion. However, Wolfspeed is currently building and transitioning its operations over to a new chip fab, a process that costs substantial amounts of money and takes time to ramp up to full production.

Long story short, this is a story of scale. As Wolfspeed grows, its margins should gradually improve until it reaches profitability, but that may not happen until the second half of fiscal 2023. The good news is there's plenty of room to scale up and get more efficient.

In comments during the last quarterly financial update, management thinks its original 2026 revenue forecast of about $2.1 billion will actually be 30% to 40% higher ($2.7 billion to $2.9 billion) thanks to rapid growth of the industries to which it supplies parts and materials.

As of this writing, Wolfspeed's anticipated growth looks priced in. The shares have more than doubled over the last three years and now trade for a lofty 19 times enterprise value to revenue. For a manufacturing company that isn't profitable yet (and manufacturing can be cyclical), it seems like a hefty price tag.

I'm not ready to pull the trigger. However, give SiC wafer testing equipment company Aehr Test Systems (NASDAQ: AEHR) a look right now. In the meantime, keep Wolfspeed on your radar.

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Nicholas Rossolillo has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Wolfspeed, Inc. The Motley Fool has a disclosure policy.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.


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