CLFD - Clearfield: Unraveling Fiber Fortunes A Hazy Path Ahead

2023-05-23 14:01:38 ET

Summary

• Clearfield, Inc. negatively surprised investors with reduced revenue expectations. So, what's next?
• Clearfield's revenue growth rates have been disappointing, and the company's profitability profile is deteriorating, with lower gross margins projected for the future.
• I make the case that, while Clearfield, Inc. stock has recently dropped by 20%, I don't believe this implies that the stock is undervalued.

Investment Thesis

Clearfield, Inc. ( CLFD ) is a fiber optic company. In my previous article , as we headed into the earnings result, I stated:

The core issue here is that investors are struggling to figure out what's the sustainable growth rate for Clearfield.

Then, on top of that, Clearfield recently diluted shareholders to bolster its cash reserves.

A month on from that statement and Clearfield stock is down 20%. So, what's next? I make the case that just because the stock is down 20% since I wrote those words does not mean that Clearfield stock is undervalued.

I continue to believe that investors would do well to avoid this name.

Revenue Growth Rates Fizzling Out

Clearfield manufactures fiber management and connectivity solutions for telecom customers, simplifying their fiber optic network and enhancing network performance.

As noted already, as we headed into the earnings results, investor expectations were misaligned with Clearfield's prospects.

See below Clearfield's guidance:

Now, after Clearfield's fiscal Q2 2023 results, Clearfield's updated guidance points to $275 million.

As an investor, your job is to attempt to get a feel for the long-term prospects of the business and seek out a bargain by paying less than the business is worth.

Put another way, as an investor you demand a margin of safety that leaves you with potential upside potential.

But if management itself struggles to figure out the medium-term prospects of the business, then the business is too volatile. And, by extension, as an investor, you require an even wider margin of safety.

In my previous article, I concluded by saying

[...] allow me to state from experience, that cheap stocks can get a lot cheaper. Particularly once management starts removing their guiding metrics, such as disclosing their future backlog figures.

As you can see from the quote above, I made the case that investors could have seen that Clearfield's prospects were deteriorating, since management sought to remove any insights into its future growth prospects, namely its backlog figures.

Why remove the backlog figures? Because it's a leading indicator of future growth. If the backlog figures didn't look compelling, investors would be less inclined to pay a high multiple for the stock.

With this context in mind, consider management's quote from the earnings call (emphasis added):

[...] throughout the pandemic, our customers ordered products earlier in their deployment schedule to stay ahead of any supply chain challenges. This just in case approach particularly at our large regional service providers, led to growth in our backlog, which reached record levels by the end of fiscal year 2022.

Here management notifies investors that the business went through a period of over-earning in 2022, and now there's a lull in its revenue growth rates. Next, we'll discuss Clearfield's underlying profitability.

Profitability Profile Turning South

When asked on the earnings call about Clearfield's gross margin profile for H2 2023, management stated that the next couple of quarters would see a sub-30% gross margin profile.

Given that in the same period a year ago Clearfield was reporting approximately 40% gross margins, for the business to be reporting less than 30% just twelve months later doesn't appear to reflect a business that has stabilized.

The Bottom Line

At the surface level, Clearfield, Inc. investors may believe that the stock is cheaply valued, since it is priced at approximately 17x this year's non-GAAP EPS figures.

However, I contend that until Clearfield stabilizes its operations and returns to top line growth, its gross margin will remain under pressure.

Meaning that until investors regain confidence in Clearfield, Inc. prospects, the multiple that investors will be willing to pay for this stock will remain compressed.

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