Credo Technology: Gets Repriced By The Market

It’s not every day that the value of a stock gets cut in half, but that is what happened to Credo Technology Group Holding (NASDAQ:CRDO), a provider of high-speed connectivity solutions for the data infrastructure market. The stock was on a tear in 2023 with gains of 45.4% at one point, only to lose it all and then some. In addition, the market has put a number of assumptions made about CRDO up in the air. Why will be covered next. We previously covered CRDO in early 2022.

The stock falls off a cliff

The chart below shows how CRDO had reason to feel good about 2023. CRDO was in the midst of a strong rally with the stock gaining 45.4% in about six weeks' time. Going back further shows the stock came close to doubling off the October lows.

However, that all changed on February 14 when CRDO disclosed the following:

“Credo’s largest customer has reduced its demand forecast for certain Credo products for reasons Credo understands are unrelated to Credo’s performance. Credo does not expect its market share with the customer will be affected. As a result of this reduction and macroeconomic headwinds, Credo now expects fiscal fourth quarter revenue, ending April 29, 2023, in the range of $30 million to $32 million. Also, Credo expects revenue for the full fiscal year ending April 27, 2024 will be flat compared to the full fiscal year ending April 29, 2023. From a projected low point in Q4 FY23 or Q1 FY24, Credo expects to see sequential growth during FY24.”

Source: CRDO Form 8-K

The impact was immediate. The stock fell 46.8% in one day in response and it has continued to fall in the days after. The stock lost all its 2023 gains and is now in a hole being down 27.5% YTD. Nevertheless, the stock is at $9.65 still above the October 12 intraday low of $9.35, which gives you a sense of how much the stock had rallied in the few months prior and up to February 14.

Implications for CRDO

A major reason why CRDO was able to rally in recent months was due to its upbeat outlook, which seemed to defy fears of a potential slowdown with a weakening global economy. For instance, CRDO stated in the Q2 FY2023 earnings call that:

“the second part is really the U.S. hyperscalers, and although we've heard that there may be a slight bending of the curve. We haven't heard that anyone is going to decrease spending year-over-year. And these are with the customers that we're engaged with that we've ramped production and we will ramp production with, so it might be a slowing of the growth, but the growth still is very significant.

I will reiterate that for us, it looks a little bit different, because we haven't reached the point of saturation and so every new product ramp that we see is next generation better than the current generation technology. And so if anything, there's still a fierce competition amongst data centers to deliver better services to their customer base in order to win market share. And so we see that there is a very, very consistent pull for next generation better than technology to get better productivity, to get better performance. And even an environment like this at a macro level, that becomes critical to be able to differentiate. So we still remain quite bullish on the customers that we're ramping. We haven't seen any major shifts.”

A transcript of the Q2 FY2023 earnings call can be found here.

Note the contrast between the recent disclosure from CRDO and the comments it made a few months ago. It would seem CRDO was premature in assuming demand would hold up as much as it assumed in light of its latest updates. Management did not foresee any major drop in demand as recently as late 2022 and this helped power the stock rally off the October lows, but CRDO has been forced to acknowledge that it was too optimistic in assuming demand would not be subject to any significant weakening.

Keep in mind that CRDO had previously forecast revenue of at least $200M in FY2023, but the latest guidance suggests it will be more like $182-186M, an increase of about 74% YoY, assuming Q4 comes in at $30-32M and way below consensus expectations of $58.3M. Flat growth for FY2024 is also a significant downgrade.

Estimates have naturally been revised. Consensus estimates expect CRDO to earn GAAP EPS of $0.01 and non-GAAP EPS of $0.04 on revenue of $54.3M in Q3. Estimates predict a loss of $0.04 in Q4, resulting in CRDO ending up with non-GAAP EPS of $0.03-0.07 on revenue of $177.8-184.2M in FY2023. The table below shows CRDO’s guidance for Q3.

Source: CRDO Form 8-K

While Q3 is predicted to grow by about 73% YoY, growth is expected to slow down in a hurry. In comparison, CRDO was growing gangbusters in the preceding months. Q2 revenue, for instance, came close to doubling with an increase of 94.4% YoY. The table below shows the numbers for Q2 FY2023 in comparison to those before.

Note that Q2 FY2022 precedes CRDO’s IPO, which explains the big jump in the numbers of shares outstanding. The sequential drop in margins can be attributed to lower contributions from IP revenue, which can fluctuate from quarter to quarter. Lower margins led to the drop in the bottom line. CRDO finished with cash and cash equivalents of $240.5M.

CRDO gets repriced by the market

CRDO may have lost half its market value in recent days, but you wouldn’t be able to tell from looking at valuations. Multiples for CRDO are still very much on the high side even with the stock price cut in half. For instance, CRDO has an enterprise value of $1.19B, equal to 72.11 times EBITDA on a forward basis and 372.72 times EBITDA on a trailing basis. In comparison, the median for the sector is 13x and 14x, respectively. Note that CRDO is not profitable on a GAAP basis, which explains the lack of GAAP P/E ratios.

Source: Seeking Alpha

Investor takeaways

Some may conclude that CRDO is worth buying with the stock price cut in half. CRDO should after all be well positioned to benefit from the rising need for datacenters. The recent rise in interest in AI as implemented by ChatGPT and other similar applications, for instance, will only increase the need to invest more in suitable datacenters.

CRDO should be able to overcome short-term hiccups like the recent cut in demand from its largest customer, which according to recent filings accounted for 44% of total revenue. The customer has decided to cut back on spending, but it wasn’t because it was dissatisfied with CRDO or its product. The long-term picture should not be impacted by the recent cut in demand. There is still reason to be bullish on CRDO stock in the long run.

However, in the short-term, the argument for long CRDO is much more debatable. CRDO still trades at extremely high valuations, even after the stock price was cut in half. While one could argue that those valuations were justified given CRDO very fast growth and CRDO deserved to trade at a premium because of it, that argument has become harder to make with growth projected to slow down to a virtual standstill.

CRDO was close to doubling revenue YoY as recently as late 2022, but the disclosure from February 14 sees FY2024 revenue staying flat YoY, down from the projected growth of 74% YoY for FY2023. The disclosure caused the market to re-assess whether CRDO will be such a winner, or at least as quickly as initially assumed. It also reminded everyone that CRDO has a narrow customer base, which is not a good thing. If CRDO can keep doubling its revenue, then those lofty multiples in the triple digits can come down fairly quickly. Not so with flat to little growth.

So while the stock has already lost half its value in recent days, it’s possible the stock goes lower with multiples where they are. The stock has only given back what it gained in the last few months. It has yet to match the lows of as recently as October, despite the recent drop. Granted, the stock is now very much oversold with an RSI of 24. A bounce is thus possible, if only because the stock is so oversold, but that does not mean the stock has bottomed.

It’s true CRDO is predicting the low point to be in Q4 FY2023 or Q1 FY2024 with sequential growth the rest of the way, but it’s also possible CRDO is forced to make further downward revisions to the outlook. CRDO was after all pretty confident demand would remain robust not that long ago, only to drastically lower its outlook on February 14. If it happened before, it can happen again.

Bottom line, there are those, especially those hunting for bargains, who like to buy stocks that have fallen a great deal. CRDO certainly fits the bill after the recent drop, but whether to step in at this time is a good move is up for discussion. There is no reason to think the market has fully priced in the implications of the recent disclosure of growth coming to a virtual halt, especially not with multiples at what many would argue lofty valuations. It’s too early to be a buyer of CRDO. Multiples need to come down and that has yet to happen. Long CRDO stock may make for a better argument down the line, but not at this time.