CRNC - Cerence Will Struggle To Grow Against Chip Shortage Backdrop

2023-04-18 18:37:56 ET

Summary

• Cerence provides AI-centric assistance technologies in mobility environments.
• The firm has suffered supply chain constraints with vehicle semiconductor shortages.
• Until those challenges are ameliorated and growth resumes, I'm on Hold for CRNC.

A Quick Take On Cerence

Cerence ( CRNC ) provides AI assistant technologies for in-automobile environments.

The company has experienced supply chain challenges from a shortage of semiconductor products in the automobile industry.

For interested investors, CRNC is certainly worth putting on a watch list, but for now, I’m on Hold until we see evidence of a return to revenue growth and other related operating metric improvement.

Cerence Overview

Burlington, Massachusetts-based Cerence was spun out from Nuance Communications in 2019 to further develop machine learning [AI] technologies to automate and enhance communications solutions for mobility environments worldwide.

The firm is headed by Chief Executive Officer Stefan Ortmanns, who previously joined former parent firm Nuance in 2003 and has extensive career experience in the speech processing industry.

The company’s primary offerings include the following:

• Cerence Co-Pilot

• Cerence Drive

• Cerence Ride

• Cloud Services

The firm acquires OEM customers via its direct business development efforts.

Cerence’s Market & Competition

According to a 2022 market research report by Grand View Research, the global market for automotive AI software was estimated at $2.54 billion in 2021 and is forecast to reach $14.8 billion by 2030.

This represents a forecast CAGR of 21.6% from 2022 to 2030, a very high growth potential, if achieved.

The main drivers for this expected growth are demand from mobility companies to improve their technology offerings, do a better job of managing vehicle activity and further develop autonomous vehicles from rising demand by consumers.

Also, the chart below shows the global automotive AI market by market share and growth forecast:

Major competitive or other industry participants include:

• Alphabet (GOOG)
• Apple (AAPL)
• Intel (INTC)
• Microsoft (MSFT)
• NVIDIA (NVDA)
• International Business Machines (IBM)
• Qualcomm Inc. (QCOM)
• Tesla (TSLA)
• Volvo Car Corporation (VOLAF)
• Bayerische Motoren Werke AG (BMWYY)
• Audi AG

Cerence’s Recent Financial Trends

• Total revenue by quarter has fallen in recent quarters:

• Gross profit margin by quarter has likewise dropped more recently:

• Selling, G&A expenses as a percentage of total revenue by quarter have trended higher in recent reporting periods:

• Operating income by quarter has worsened recently:

• Earnings per share (Diluted) have turned negative in the last four quarters:

(All data in the above charts is GAAP)

In the past 12 months, CRNC’s stock price has fallen 16.2% vs. that of the iShares Expanded Tech-Software Sector ETF’s ( IGV ) drop of 5.5%, as the chart indicates below:

For the balance sheet, the firm ended the quarter with $109.3 million in cash, equivalents and short-term investments and $279.8 million in total debt, of which $12.5 million was due in less than twelve months.

Over the trailing twelve months, free cash used was $23.1 million, of which capital expenditures accounted for $13.7 million. The company paid $34.7 million in stock-based compensation in the last four quarters.

Valuation And Other Metrics For Cerence

Below is a table of relevant capitalization and valuation figures for the company:

(Source - Seeking Alpha)

The Rule of 40 is a software industry rule of thumb that says that as long as the combined revenue growth rate and EBITDA percentage rate equal or exceed 40%, the firm is on an acceptable growth/EBITDA trajectory.

CRNC’s most recent GAAP Rule of 40 calculation was negative (9.8%) as of FQ1 2023’s results, so the firm has performed poorly in this regard, per the table below:

(Source - Seeking Alpha)

Future Prospects For Cerence

In its last earnings call (Source - Seeking Alpha), covering FQ1 2023’s results, management highlighted seeing additional demand from two-wheel customers as an ‘important adjacency’, with recent wins helping the firm deal with a challenging macroeconomic environment.

Additionally, the company continues to experience semiconductor shortages, negatively impacting its production throughput.

Despite this, management raised the lower end of its fiscal full-year guidance to $275 million, with $283 million as the midpoint of the new range representing a forecasted revenue drop of 10.8%.

Also, while GAAP operating margin is expected to be negative (16.5%) at the midpoint, earnings per share is forecast to be negative ($1.65).

The company's financial position is in relatively good shape, with liquid resources equal to 4.7 years of trailing twelve-months free cash burn.

The primary risk to the company’s outlook is a macroeconomic slowdown or recession, which may reduce vehicle sales growth and reduce its revenue growth trajectory.

Also, consumer credit availability may also present a drag on new vehicle sales as banks reduce their lending activity in the wake of the recent U.S banking crisis.

A potential upside catalyst to the stock could include reduced supply chain bottlenecks and greater semiconductor throughput, although even management is very cautious about the prospects for anything other than slow improvement in this regard.

While the company sees growth in monthly active users of 19% year-over-year, its global automobile penetration growth has grown by only 1% [TTM], to 52%, so it appears the firm has hit a plateau of sorts in its penetration growth.

CRNC’s stock price has likely caught a tailwind from the recent surge in interest in ‘AI’ technologies from consumers, and we shouldn’t discount that, but the greater challenge for management is the constraint on new vehicle production from the ongoing semiconductor industry production shortages.

And, with the U.S. government’s efforts to onshore or near-shore semiconductor production for national security reasons, the industry is undergoing further shifts in design and production supply chains, which will likely continue for years to come.

For interested investors, CRNC is certainly worth putting on a watch list, but for now, I’m on Hold until we see evidence of a return to revenue growth and other operating metrics.

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