SMART Global Holdings Stock: Upcoming Results Could Shine Light On AI Play (NASDAQ:SGH)

SMART Global Holdings (NASDAQ:SGH), a designer and supplier of high-performance, high-availability enterprise solutions, is scheduled to release its Q3 FY2024 report and the latest guidance on July 9. In response, the stock has rallied recently after a big drop, but the shorts have also been upping their bets in the apparent belief the stock could collapse like it did after the last report. However, there is an X factor that could give the upcoming report another twist. Why will be covered next.

The stock keeps coming back

A previous article from last March rated SGH a hold after concluding there were several reasons why caution was warranted. For instance, the stock was in the midst of a powerful rally at the time that had already lasted months, enabled in large part by the euphoria surrounding AI, but this raised the risk SHG could fall short of expectations and disappoint with SHG scheduled to release its Q2 FY2024 report in early April.

The chart above shows why the article was rather prescient to end with the statement to “thread with caution” because the stock lost 24.1% of its value on April 10 after the Q2 FY2024 report fell short of expectations. The collapse was reminiscent of an even bigger selloff in October 2023, which also came in the wake of an earnings report that disappointed.

Also similar is how the stock has recovered a large part, but not necessarily all, of the post-earnings losses in both instances. The stock hit a 2024 low of $16.80 on April 19, bringing post-earnings losses to 35.2%, but the stock has since gained 33.3% after closing at $22.39 on June 25. Note how the stock has trended higher in recent weeks. The stock is still way below where it traded prior to the most recent report, but it is now up 18.3% YTD.

There is more to this story. The bounce following the April 19 low of $16.80 was likely no coincidence. The stock rallied from a low of $13.10 on October 13, 2023 to a high of $27.22 on April 1, 2024, and the 76.4% Fibonacci retracement of $13.20 to $27.22 is $16.43, which is very close to where the stock rebounded at $16.80 on April 19, 2024.

This suggests support exists in the $16-17 region, which halted the stock’s decline to send it upwards. Furthermore, it suggests there are investors out there that remain bullish on SGH or they would not have stepped in at a potential support level. They did so even though the last report did not meet expectations, which suggests they believe SGH can and will do better.

The shorts are upping their bets

However, while bulls are out there, so too are the bears and they are upping their bets. According to data from the Nasdaq, short interest rose to 4,924K shares on 5/31/2024, the highest it’s been in 2024, and almost twice as high as where short interest was on 1/31/2024 at 2,505K. This translates to a short float 9.76%, or close to the double-digit level many start taking notice.

This shows there is a lot of pessimism directed towards SGH. The numbers for June have not yet been released, but the increase in short interest comes at a time SGH is scheduled to release its Q3 FY2024 report on July 9. The increase in shares sold short could be interpreted as a sign the bears are increasingly confident SGH will come up short once again with the upcoming report.

Why the stock sold off after the Q2 FY2024 report

Bears seem to be betting the upcoming Q3 FY2024 report will turn out to be a repeat of earlier reports, which were followed by a massive drop in the stock. This includes a 44.4% drop after the Q4 FY2023 report and a 24.1% drop after the most recent or Q2 FY2024 report. The table below shows the numbers in the Q2 FY2024 report, which was followed by a selloff in the stock.

Keep in mind Q2 FY2023 preceded the sale of a majority stake in SGH Brazil and thus included contributions from a divested asset, which skews the YoY comparisons with Q2 FY2024. Revenue and non-GAAP EPS increased QoQ in Q2 FY2024, but were down YoY. SGH finished the quarter with cash, cash equivalents and short-term investments of $465.77M and long-term debt totaling $740.66M.

Click to enlarge

Source: SGH Form 8-K

The numbers may not seem all that bad, but remember SGH is supposed to be an AI play, specifically through its Intelligent Platform Solutions or IPS unit. The IPS unit contributed $141.41M in Q2 FY2024, which is more than Q1 FY2024’s $118.82M, but less than Q2 FY2023’s $222.45M. The other two units, Memory Solutions and LED Solutions, partially offset the sequential growth in IPS.

However, SGH guided for IPS revenue to be flat or slightly up in Q3 FY2024, which was arguably what hogged the spotlight. AI is supposed to result in turbocharged growth and flattish growth is inconsistent with the thesis that AI will power growth forward. From the Q2 earnings call:

“Our guidance for the third quarter reflects the following. For IPS, we expect revenues to be flat to slightly up at the midpoint, with additional opportunities that may fall in the third or fourth quarter depending on the timing of deployments.”

Source: SGH earnings report

What the market expects from the Q3 FY2024 report

The consensus is that SGH will report non-GAAP EPS of $0.31 on revenue of $301.5M, which are slightly above the midpoint of guidance from SGH as shown below. So expectations for the Q3 FY2024 report are pretty modest with a $0.03 sequential improvement to EPS, similar to the preceding Q2 FY2024, but the market will be curious to know if SGH calls for earnings growth to accelerate with its upcoming quarterly guidance. It will also be interested in knowing what the contributions are from the IPS unit because it would provide clues as to whether or not SGH is benefiting from AI.

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Source: SGH Form 8-K

The consensus is that SGH will guide for non-GAAP EPS of $0.40 in Q4 FY2024, an $0.09 QoQ improvement to EPS, which is much faster than the preceding quarters. This number implies non-GAAP EPS of $1.22 in FY2024, which would give SGH to a P/E ratio of 18.4x with the stock priced at $22.39. This is below the sector median of 23.4x, but above where SGH has traded on average in the last five years at 10.4x. In terms of GAAP, SGH is headed for a loss.

Has the time come to question whether SGH stands to benefit from AI as speculated?

SGH has benefited from being perceived as a potential play on AI. This has been the case since AI set off a search for AI plays in May 2023. Ideally, the IPS unit, which offers HPC hardware and services, would benefit the same way a company like Super Micro Computer (SMCI) has seen sales spike thanks to AI-related demand for servers and related products. However, a year has passed and SGH still does not have all that much to show for.

Granted, SGH is more than just the IPS unit, and other units like memory have been affected by headwinds, but SGH does not appear to be reaping the fruits of AI like some other companies are. This can change of course, but that is how it appears as of this moment. If SGH is not seeing growth spike due to AI, then it may be time to ask whether SGH deserves to be labeled an AI play.

Could SGH pull a rabbit out of a hat?

If rising short interest is any indication, then more and more people seem to be questioning the validity of the AI thesis for SGH. The last guidance calling for flattish sales in the IPS unit runs counter to the notion that AI will drive demand at SGH. However, it needs mentioning that SGH is trying to win business that can be lumpy in nature.

This means flat growth in one quarter can be followed by a huge jump in sales in another quarter. It’s quite possible SGH may call for strong growth in its upcoming quarterly guidance thanks to the IPS unit. Keep in mind that if Q3 comes up flat, there might be some making up to do in Q4 and this could play a role in ensuring guidance comes in better than expected. If this happens, the stock could soar higher because it would reaffirm the AI thesis. Stronger than expected guidance could also force shorts to cover, which would amplify gains.

Shorts have upped their bets, but they do run the risk their bets could backfire. There is no question companies are interested in incorporating AI into their business and while SGH may not have done all that much, that could change in a hurry. Lumpiness is thus something of an X factor that could affect how the upcoming Q3 FY2024 report/Q4 FY2024 guidance could play out for both the bulls and the bears.

Investor takeaways

July 9 is shaping up to be a very volatile day for SGH. The bulls have been bidding up the price of the stock after it sold off after the Q2 FY2024 report disappointed by calling for flattish growth in the IPS unit in Q3 FY2024, which raised doubts about the soundness of the AI thesis. This suggests the bulls still believe in SGH as an AI play and are looking past previous reports in anticipation of future AI-driven growth.

On the other hand, shorts are taking up the other side of the bet. Short interest has been going up, and it is now at the highest it’s been in 2024. This suggests the shorts expect the Q3 FY2024 report, or more specifically Q4 FY2024 guidance, to go badly. The stock fell off a cliff after two of the last four quarterly reports, including the most recent or Q2 FY2024 report, and the increase in the number of shares sold short is a sign shorts are looking for an encore when SGH reports once again.

Keep in mind that while the stock sold off in two of the last four times SGH reported, the stock jumped higher by double digits the other two times SGH released a quarterly report. Both the bulls and the bears seem to be convinced they are on the right track, but both cannot be right. Each of the last four reports that have been released since interest in SGH went up in the wake of the AI euphoria were followed by big moves in the stock, up or down, which suggests either the bulls or the bears are headed for a shellacking. What remains unanswered is which side it will be.

The last time the bulls got punished, and the bears got rewarded when the stock collapsed. This was the opposite of what happened in the preceding report, just as that one was the opposite of the one before. If this pattern holds, it will be the turn of the bears to take a beating and it will be the turn of the bulls to come out on top when SGH reports on July 9.

However, past performance is not indicative of future results and there are no guarantees the stock will not suffer like it did after the Q2 FY2024 and Q4 FY2023 reports. The X factor here could be what happens in the IPS unit, which is considered a barometer of how AI is going for SGH. Sales here can be lumpy, which means SGH could pull a rabbit out of a hat when it releases its next quarterly guidance.

I would not be short SGH with the above in mind, but I do not believe long SGH is warranted as long as it is debatable whether SGH deserves the label of an AI play. I am therefore neutral on SGH. Both the bulls and the bears appear to be upping their bets as July 9 draws closer, but it is too close to call who will come out on top. History suggests one side will win big and the other side will lose big, but which is which is still under wraps.