CRDO - Credo Technology: Expectations May Be Too High From Upcoming Q2 Report

2023-11-23 03:42:21 ET

Summary

• Credo Technology Group is scheduled to report on November 29, and the stock has rallied to close to all-time highs in anticipation of CRDO having good things to say.
• CRDO suffered a major setback earlier in the year and the market expects CRDO to show it is getting back to its old ways of turbocharged growth.
• There are a number of reasons why some may want to head into the next report with caution, especially when so much is expected.
• The stock is riding high, especially with CRDO seen as an AI play, but those conditions could be fertile ground for disappointment.

Credo Technology Group Holding ( CRDO ) is heading into the release of the upcoming earnings report on November 29 with momentum after gaining an impressive 27% since the start of November. The stock has recouped almost all the big losses from earlier in the year after CRDO announced growth would be less than anticipated due to weaker-than-expected demand. The stock is now closing in on new all-time highs. Still, CRDO has seen growth take a major hit, but the market has given CRDO the benefit of the doubt that it will be able to recover lost ground soon enough. Why will be covered next.

CRDO has been hot lately

A past article from last May rated CRDO a hold after the stock managed to double in price in roughly three weeks with AI playing a big role. CRDO had sold off earlier after CRDO warned in February growth would be much slower than the turbocharged pace expected and displayed earlier. FY2024, for instance, was not expected to show any growth with revenue staying flat YoY.

However, the entry of AI came to the rescue. CRDO lost almost half its value in February after revising the outlook in light of weaker demand, but the AI-induced rally starting in May helped erase those losses after speculation arose CRDO could stand to benefit from the rise of AI in light of blowout earnings from NVIDIA ( NVDA ).

CRDO is a supplier of high-speed connectivity solutions for the data infrastructure market. In theory, increasing adoption of AI applications should increase the need for higher bandwidth and data transfer rates, which suggests a company like CRDO should be able to ride the AI wave higher, especially if AI grows as fast as many expect it to.

The chart above shows how AI triggered a powerful rally in May/June, which ended when the stock closed at $18.52 on June 20, and the stock peaked as high as $19.07 if intraday highs are included. Keep in mind CRDO has reported major declines in sales and profits in recent quarters, but the stock has benefited from CRDO being perceived as a company that stands to reap the benefits from the rising adoption of AI. The market has been looking for AI plays and CRDO is seen as one.

However, the stock was not able to gain much more in the following months. It's been mostly sideways, but the stock has put together another strong rally in November. This has resulted in a stock that is up 35.8% YTD after closing at $18.07 as of November 21. To put this in perspective, the stock was down 46% for the year after hitting a 52-week low of $7.20 on May 4 before the entry of AI changed everything for CRDO. So it has been quite a turnaround.

Could CRDO disappoint?

It’s worth mentioning that CRDO is scheduled to release its Q2 FY2024 report on November 29. CRDO reported losses in the last two quarterly reports due to the setback mentioned earlier, but CRDO is expected to continue on the path to recovery by getting back to breaking even in the upcoming report. Using the guidelines as laid out by guidance from CRDO shown below, consensus estimates expect CRDO to report non-GAAP EPS of $0.00 on revenue of $42.6M.

Source: CRDO Form 8-K

In comparison, the table below shows the preceding quarters. Keep in mind Q1 FY2024 and Q4 FY2023 came after CRDO lowered the outlook due to lower demand from its largest customer. If Q2 FY2024 comes in as expected, then revenue will have increased sequentially for two straight quarters, a positive sign CRDO is recovering from the setback earlier in the year.

Source: CRDO Form 8-K

The market will also be looking for updates as to how CRDO sees growth in the coming quarters. CRDO had earlier suggested FY2024 revenue would be similar to FY2023, which implies FY2024 revenue of $184M. If H1 FY2024 revenue comes in at around $78M according to guidance, then H2 revenue needs to be around $106M. Keep in mind consensus estimates put FY2024 revenue even higher.

This requires quarterly revenue to get back to the quarterly high of $54M reached in Q3 FY2023, which was the last quarter before CRDO was forced to lower its outlook due to weaker demand from its largest customer. In other words, if CRDO hits its targets, CRDO should have recovered from the recent dip by the end of FY2024.

However, it’s worth mentioning that CRDO alluded to potential hiccups in H2 FY2024 at the last earnings call. While CRDO expects sequential growth throughout FY2024, CRDO seemed to be cautious about the state of demand in H2. From the Q1 FY2024 earnings call:

“We're pleased to see FY '24 continue to play out as expected. While we see some near-term upside to our prior expectations, the rapid shift to AI workloads has driven new and broad-based customer engagement.

We expect that this rapid shift will enable us to diversify our revenue throughout fiscal year '24 and beyond as Bill alluded to. However, as new programs add new and existing customers ramp, we remain cautious about the back half of our fiscal year until we gain better visibility into forecasts.

In summary, as we move forward through fiscal year '24, we expect sequential revenue growth, expanding gross margins due to increasing scale and improving product mix, and modest sequential growth in operating expenses.”

A transcript of the Q1 FY2024 earnings call can be found here .

CRDO is priced for fast growth

Still, the market expects to hear good news from CRDO on November 29 if the recent price action is any clue. The stock has rallied and it is not far from the all-time high of $19.46 set in February 2023, just before CRDO lowered its outlook and the stock collapsed. The market does not anticipate any speedbumps like the one earlier in the year.

This can be seen in how the stock price has risen even though earnings have fallen into negative territory. FY2024 is shaping up to end up flat compared to FY2023, but CRDO trades like a high-growth stock. The table below shows how multiples for CRDO are in the triple digits in several instances. For instance, CRDO trades at almost 8 times book value with a market cap of $2.7B. CRDO is priced for growth.

Source: Seeking Alpha

Is some caution warranted with regard to CRDO?

The market does not expect any bad news from CRDO. On the contrary, the market seems to be expecting to hear good news at the next conference call. On the other hand, it is not impossible for CRDO, or any other company for that matter, to come up short if the bar has been set high enough. When expectations are high and no one is prepared for any bad news, that’s when things can go wrong.

It’s thus worth mentioning that not everyone seems to be benefiting the way NVDA seems to be. Marvell ( MRVL ) for instance, can be argued to be CRDO’s principal competitor as it too focuses on the data infrastructure market, especially after its acquisition of Inphi Corp. MRVL too can be argued to be a beneficiary of the AI boom, but the company has yet to see much of a boost from AI.

Granted, MRVL is not just focused on AI and it is true soft semiconductor demand has affected MRVL, as it did with many other semis. It’s also true that just because a competitor is not doing great, then that does not necessarily mean CRDO cannot do much better. It’s possible one company can execute much better than another one when they are presented with the same opportunities.

Still, it’s possible CRDO may not see as much of a boost from AI as many seem to believe, especially in the short term. It’s possible that expectations may be too high. There may be growth due to AI, but it may take longer for it to arrive. This could potentially become a problem for the stock because it is priced for fast growth, even though it has not shown any of it in recent quarters.

Can CRDO be said to be overvalued?

Fair value is subjective, but an argument can be made that CRDO is trading above fair value, especially after the recent rally. Expectations are that CRDO will end FY2024 with revenue in the $188-194M range. If we assume CRDO comes in at the high end of expectations with FY2024 revenue of $194M, then revenue could grow to $777M over the next five years with a CAGR of 32%.

This would grow free cash flow from $17M to $133M during this time frame. If we then assume a discount rate of 9.7-9.8% and use the discounted cash flow method to come up with a fair value for CRDO, then an argument can be made that fair value for CRDO is about $8.60. Keep in mind it is possible the above numbers may be too conservative because CRDO could grow much faster than the above estimate assumes. Nevertheless, a fair value of $8.60 is way below the current stock price.

Putting shares up for sale could limit gains

It’s probably also worth mentioning that there have been a lot of insider sales recently at CRDO. The table above shows some of the transactions that have taken place in just the last week. To be fair, all these transactions were pursuant with trading plans announced earlier. Still, the fact that shares are put up for sale could limit gains in the stock price, at least in the near term.

Investor takeaways

CRDO is scheduled to release its Q2 FY2024 report on November 29 and the stock has rallied with a gain of around 27% in November in anticipation of what the market suspects will be strong results. The stock seems poised to break the old highs from earlier in the year. NVDA’s latest report shows the AI boom remains alive and well and much is expected from CRDO when it reports next.

After all, there is a reason why the stock is in the midst of a powerful rally heading into earnings. Guidance in particular will be important since CRDO is expected to show clear signs it has recovered from the recent slump that has caused growth to stall due to weaker demand, including from its largest customer.

This slump has caused growth to reverse after a period of rapid growth at CRDO, but the market believes CRDO will return to its old ways before FY2024 is done. Quarterly revenue has dipped in the last couple of quarters, but if forward projections are any indication, quarterly revenue in H2 FY2024 is expected to equal, if not surpass, the record high.

However, after the furious rally this month and with expectations high, it may be time for caution. The bar has been set high, but that also means there is a risk CRDO could come up short. Keep in mind competitors have not exactly hit the ball out of the park with their recent reports. Multiples can be said to be in lofty territory and there is an argument to be made CRDO is already above fair value.

I am neutral on CRDO. The stock is red hot right now, but it may be time to consider taking some chips off the table with the next earnings report due in a week. No bad news is anticipated and lots of good news is expected, which might happen, but maybe too much to ask for, especially in light of what has happened recently at CRDO or at the competition. If there is some bad news, the market or the stock is not prepared, certainly not after the strong rally and with valuations where they are. Tread with caution.

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