Keysight: Q3 Marks An Inflection Point, But Valuation Is Tight (NYSE:KEYS)

Investment Thesis

Keysight Technologies, Inc. (NYSE:KEYS) is a company that provides electronic design and test instruments, and being one of the world leaders in this sector.

As covered in my past articles, FY2024 hasn’t been easy as orders have paused and revenue has decreased drastically, however, in this follow up I can notice that an inflection point appears to have been reached, giving hope that growth can return. The stock is rising to $155, quickly adjusting for this positive news in the valuation, but if it returned to around $140, it would seem like a buying opportunity to me.

Q3 2024 Gives Hope

On August 20, Keysight reported revenue of $1,217 billion, which represented a 12% year-over-year decrease. Although this is not positive at all, it was better than analysts expected because management itself had warned that Q3 would be weak (guidance of revenue between $1.18B and $1.20B), so it seems positive that the company’s own expectations are surpassed.

Regarding EPS, there was also a big beat of 16% with respect to the expectations given in Q2 (between $1.30 and $1.36, you can take a look at my coverage of Q2 here). In this case, we’ll look at non-GAAP EPS because GAAP EPS was $2.22 or 38% YoY growth, but this is due to a positive tax adjustment of $1.13 per share to reflect an amortization deduction.

Click to enlarge

So in the first nine months of FY2024, the company reported $3,692 billion in revenue, a decrease of 11% year over year. Management’s comment is to earn between $1,245 and $1,265 billion, so if the high end of the guidance is met we’d be talking about a decrease of only 3.5% year over year.

There’s one thing that gives hope that this could be achieved and that an inflection point has already been reached. If we look at the new orders received, since Q1 2023 (the last six quarters) these had decreased year over year, but in this quarter for the first time, positive numbers of 0.4% YoY were obtained. If this positive trend continues, it won’t take long for us to see growth again after a complicated FY2024.

Some Concerns Too

Regarding this positive trend, management was cautious and commented that although it is positive to see this trend, there are still aspects that are not completely resolved.

There’s some incremental weakness in the automotive sector. So we put it all in the blender, and say, in this current environment, we’re encouraged by this returning to slight year-over-year growth as we’ve seen, but it might be too soon to call a recovery at this time.

CEO Satish Dhanasekaran in Q3 2024 Earnings Call.

We must not forget that the company has clients from cyclical industries such as automotive, electronic components, or semiconductors. Therefore, while the company’s products solve a critical mission, they’re also closely tied to the capital expenditures of its customers. If clients are having difficult months due to the cyclical nature of their products and the current macroeconomy, it would be normal for them to pause investments temporarily, and therefore Keysight ends up suffering from this slowdown too.

Valuation

If we take into account the Q3 report, the non-GAAP P/E for the last twelve months would be around 21 times (EPS of $6.60) and the GAAP P/E would be 26 (EPS of $5.20) at the current price of $138 per share. However, as of this writing, the stock is up 11%, hitting $155 per share, so at that price range, the non-GAAP P/E would be 23 times the trailing twelve months.

It doesn’t seem like the stock is exactly cheap, not even without considering the after-hours price action. Currently, it would currently be trading at the sector average and its own average for the last five years. Therefore, there doesn’t seem to be any upside in terms of multiples.

If we take into account the guidance for Q4, the company would end up doing around $6.16 in non-GAAP EPS or a year-over-year decrease of 25% according to my estimates, therefore the P/E considering FY2024 would be 22 times at the price of $138.

On average, EPS has grown 20% annually since 2014 and the business continues to have possibilities for growth thanks to trends such as artificial intelligence, data centers, and the electrification of things, among others. If during FY2025 the EPS grows 15% due to the rebound effect of the reactivation of orders that seem to be paused, then $7 of EPS would be made and the forward P/E would be 20 times at $138 per share and 23 times at $155. So, around $140 per share would be my ideal entry price since it would represent buying at a forward P/E of 20 times, which would be an interesting discount from its average of 23​.

The Bottom Line

I think Keysight is already seeing the light at the end of the tunnel, and having a quarter of increasing orders year-after-year makes me think that growth will be reactivated. The company can take advantage of macro trends and its products are relevant for clients, so it continuing to grow in the future seems realistic.

Sadly, the price action seems to be quickly incorporating this into the valuation, so it doesn’t seem like a buying opportunity to me at more than $140 USD per share (a forward P/E of 20). Therefore, my rating will be to hold considering that the price is rising to $155.