GLW - Clearfield: 'High Speed' Growth Outlook Keeps Us Bullish

Summary

• Clearfield is capturing strong demand for its fiber optic cable management solutions.
• Subsidies through the U.S. Infrastructure and Jobs Act are expected to remain a major growth driver over the next decade.
• We are bullish on the stock, which is supported by overall solid fundamentals.

Clearfield, Inc. ( CLFD ) is a leading manufacturer of specialized broadband fiber management and protection equipment. For the less technically inclined, these products would be recognized as endpoints in specialized panels, assemblies, and terminals critical to network applications. The attraction here is exposure to high-growth themes between fiber-to-the-home ((FTTH)) community broadband, and 5G infrastructure, which have received a boost from subsidies through the Infrastructure Investment and Jobs Act passed into law in 2021.

Indeed, CLFD has already been a winner with shares up more than 30% last year, amid record growth and earnings. We like the stock, which checks off several boxes as a high-quality small-cap with several tailwinds supporting more upside in 2023. While shares have faced higher volatility, we view the pullback from the recent high as a new buying opportunity at an attractive entry point.

CLFD Key Metrics

The company reported its fiscal 2022 Q4 results in November with EPS of $1.22, beating expectations by $0.36, and up 130% from $0.53 in the period last year. It was an otherwise blowout report with revenue of $95 million, more than doubling from $45.2 million in Q4 2021, inclusive of a $7 million contribution from the company's July acquisition of Finland-based "Nestor Cables".

Even as the gross margin at 39.5% narrowed from 43.6% with management citing some overhead costs at its new manufacturing facilities in Minnesota and Mexico, the takeaway here was the significantly higher profitability. With the top-line momentum and sales mix, the operating margin climbed to 23.4% from 20.7% last year as expenses declined sharply as a percentage of revenue, benefiting from a more efficient scale. For the full-year 2022, sales climbed by 97% to $271 million while EPS of $3.55 increased from $1.47 in the year prior.

The story here has been the strong demand for fiber optics solutions, particularly in the community broadband segment. Looking back at the pandemic, many small cities and rural communities recognized the urgency to build out an infrastructure for residents to access high-speed internet. These efforts translated directly into plans put in place by tier 2 telecom providers to deploy a local network, utilizing Clearfield components.

The dynamic is also captured from Multiple Systems Operator (MSOs) which represent more national telecom customers like Verizon ( VZ ), for example. Here, the rollout of wireless 5G services has driven demand for specialized equipment as components in project developments. One example would be a deployment at a major public venue or even a sports stadium upgrading its connectivity systems.

There has also been a shift where multi-family residential communities or settings like college dorms have added to a cycle of upgrades, beyond new construction. Overall, the backdrop is a strong operating environment that has thus far been largely resilient to any economic downshift.

On this point, the acquisition of Nestor Cables is seen as a game changer as the deal further vertically integrates Clearfield by bringing in-house a key supplier of fiber optic cables. The effort is expected to drive synergies going forward while reducing supply chain lead times as accreditive to earnings.

Management issued fiscal 2023 guidance, targeting net sales in a range between $380 Million to $393 Million. If confirmed, the growth would represent a 40% to 45% increase over 2022. An order backlog that reached $165 million compared to 66 million at the end of the year prior adds some confidence that the trends are achievable.

Finally, we can mention CLFD ended the year with $22.5 million in cash and equivalents more than covering the $18.7 million in long-term debt. Curiously, even with the underleveraged balance sheet, the company announced a $100 million equity offering capital raise which was ultimately upsized to $120 million in early December as net proceeds. With the only explanation being the use for working capital and general corporate purposes, it's assumed Clearfield could be preparing for another strategic acquisition, although nothing has been announced.

CLFD Stock Price Forecast

The strength of Clearfield comes down to its focus on fiber management components. This is in contrast to other companies cited as competitors in its annual report like Corning Inc. ( GLW ), Nokia Oyj ( NOK ), CommScope Holding Company, Inc. ( COMM ), and Vertiv Holdings Co ( VRT ) among others which offer similar solutions but otherwise have a broader scope in terms of their overall business.

By this measure, Clearfield has a competitive advantage when working with customers as effectively a one-stop shop for end-to-end fiber delivery solutions. Furthermore, management explains that its proprietary designs like the "FastPass Connect" system cut the install time per home by 50% compared to legacy install methods as a value proposition.

It's clear there are several high-level growth tailwinds that are expected to continue. Clearfield views the U.S. FTTH as representing a $12.5 billion addressable market still in the early stages. With 5G, the outlook is for the segment to grow at an average annual rate of around 48% through 2030 to reach $200 billion.

A lot of this is tied to commitments under the Jobs Act for 100% broadband coverage in the U.S. by 2030 with over $100 billion in subsidies including tax incentives allocate for deployment over the period. In all, the Fiber Broadband Association notes there are over 40 funding programs at the state and Federal levels. Simply put, Clearfield is well-positioned to capture a good chunk of those investments.

According to consensus estimates, the forecast is for annual revenue growth to average 33% through fiscal 2025, including the 43% increase this year in line with management guidance. Naturally, the earnings momentum should follow and the market outlook for 25% EPS growth this year followed by just a 15% increase in 2024, is one area that could prove to be conservative.

In a scenario where the macro backdrop improves with stronger economic momentum going forward, a bullish case for the stock could see the company outperform expectations. In our view, there is likely some room to improve margins, driven by pricing initiatives or even some targeted and accretive acquisitions down the line into value-added component manufactures.

We can also bring up that the company also intends to expand internationally, which contributed to just 7% of total net sales last year. Overall, this is a stock that, in our opinion, has a path to eventually reach an annual $1 billion in sales over the next decade.

In terms of valuation, there are plenty of reasons to see why CLFD should command a premium given the growth trajectory and financial profile. In our view, its forward P/E multiple at 21.4x at a premium to that same group of competitors and peers like GLW, COMM, NOK, and VRT with an average closer to 11x is justified and likely has room to even widen given its trend of consolidating market share.

What About Risks?

Thus far, our note has taken a decisively positive tone, but it's important to recap what could go wrong. One of the challenges this year has been the financial health and operating trends of telecom providers as core Clearfield customers. This segment has historically been seen as otherwise defensive but remains exposed to changing economic conditions. For example, Verizon has announced its plans to cut back on capital spending , while noting it has largely completed its 5G rollout.

While the company is just a small part of Clearfield's customer base, the effort could be a sign of a softer trend in the sector overall. A deterioration in the broader macro environment would likely force companies to rethink strategic investment in broadband, or at least push back plans against the uncertainty.

CLFD Stock Price Forecast

Putting it all together, we're bullish and view risks tilted to the upside. We rate CLFD as a buy with a price target for the year ahead at $130, implying a 27.5x multiple on the current consensus fiscal 2023 EPS. From the stock price chart, $130 is a level shares traded at as recently as November, with some of the volatility reflecting mixed economic data over the period. On the other side, $90 has worked as an important area of support, with the recent bounce setting up the renewed positive momentum.

While a date has not yet been confirmed, the fiscal Q1 earnings report will likely be released later this month as the next opportunity for management to provide an update on current conditions. Monitoring points will include the operating margin levels and trends in the order backlog as a sign of the ongoing sales momentum.

Into that report, the risk is that weaker-than-expected sales and earnings below consensus estimates could drive renewed volatility and open shares for a leg lower. At the same time, we're not expecting too many surprises given the relative stability of the sales cycle, which has been relatively consistent with low variability every quarter for the last several years.

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