Aehr Test Systems (AEHR 5.49%) has been on a wild ride. Shares of the tiny chip manufacturing equipment company have been all over the board in the last year as the market tries to get a handle on the company's biggest growth driver right now: The electric vehicle (EV) market. Its latest trick has been a more than 50% bounce following the second-quarter fiscal 2023 earnings update (the three months ended November 2022). Aehr beat financial expectations, but this recent surge in optimism has less to do with EVs and a lot more to do with data centers.
A massive new market even bigger than electric vehicles?
On the surface, Aehr stock's recent run-up has everything to do with the last quarter's results. Revenue was up 54% year over year to $14.8 million, and net income was $3.73 million (compared to just $717,000 last year). Both figures handily beat market analyst predictions as Aehr reported two new customers ramping up production of silicon carbide (SiC) chips, adding fuel to the SiC fire that Aehr's leading customer ON Semi (ON 6.24%), as well as SiC pioneer Wolfspeed (WOLF 8.46%), have helped start. The EV market is quickly displacing legacy autos, and Aehr's equipment that tests SiC chips needed in EVs could enjoy strong demand for the duration of the 2020s.
However, as a cyclical manufacturing business that relies on hard-to-predict timing of customer orders for equipment, Aehr has been playing coy with investors. Despite a stellar first half of the current fiscal year, CEO Gayne Erickson and the top team have simply reiterated their outlook for full-fiscal year 2023 revenue to be $60 million to $70 million -- implying growth of 18% to 28% from 2022.
Erickson and company have always maintained that Aehr has other growth verticals outside of EVs, though, and the company provided more than a passing hint at what that is during the last earnings call: Data centers, specifically silicon photonic chips. Through the first half of the current fiscal year, Aehr has reportedly shipped over $5 million in upgrade equipment to silicon photonics manufacturers, up more than 300% from 2021.
Analysts were intrigued, especially by Erickson's further allusion to this being just as big a market, or bigger, for Aehr than EVs. Erickson had this to say when queried about the matter:
So with the announcements by some major suppliers, the 2 largest microprocessor suppliers in the world, the main graphics processors companies in the world, even some of the large fabs like [Taiwan Semiconductor Manufacturing (TSM -0.34%)] and GlobalFoundries (GFS 2.07%) have created these consortiums to talk about heterogeneous integration, which is a fancy word for multiple chips in one package that include fiber optic transceiver ports on it. And what they're saying is servers first are going to start having chipsets that are in communication with processors and disk drives and data storage through fiber optic ports directly.
In laypersons' terms, data center chips need to get faster to support cloud computing and artificial intelligence applications. As chip designers and manufacturers -- including top semiconductor names like Intel (INTC 0.64%), Nvidia (NVDA -3.33%), AMD (AMD -0.35%), and others -- push the current limits of chip technology, silicon photonics (which transmit data from chip to another) could help push those boundaries a bit further. And Aehr Test Systems equipment could play a very large role in the manufacture of those photonics.
Not much has changed, at least not yet
Silicon photonics already have some use today. For example, photonic chips are used in the 2D and 3D sensing chips used in fingerprint readers and facial recognition capabilities in some high-end smartphones (like Apple's (AAPL 1.27%) iPhones). However, as Erickson pointed out on the call, those photonic devices are only on for seconds during the lifetime of the phone, since a biometric or facial scan takes milliseconds to complete. The testing requirements for such photonic chips are minimal as a result.
But things change with silicon photonics used for data transmission, like in a massive data center, where the device will be in use constantly. Testing of the device will be stringent, which leads Erickson to now believe that the silicon photonics market could eventually be larger than SiC for the auto industry.
The key word here, though, is "eventually." For now, EVs are what is powering Aehr's financial results. Photonic connections in data center chips won't start really showing up until "the second half of this decade" -- 2025 and beyond. That's still a couple of years away, and it remains to be seen how much new business Aehr could pick up from these manufacturers that might start implementing this new technology.
After this last update, Aehr stock trades for over 61 times trailing 12-month earnings per share. Current year expected growth looks handily priced in, and I'm not inclined to add to my position here. For the record, my fair value estimate on Aehr is about $20 a share, though that is by no means a price target or estimate on where I think the stock will head next. However, exciting things are afoot over at Aehr Test Systems. Keep this small chip company on your radar as it begins to expand into new markets like data centers.
