Credo Technology: The Moment Of Truth Draws Near

Credo Technology Group Holding (NASDAQ:CRDO), a provider of high-speed connectivity solutions for the data infrastructure market, has staged a strong comeback in recent weeks. The stock fell to a new low as recently as May 4, part of an extended decline that was triggered by CRDO lowering its outlook for FY2023 and FY2024. However, the stock has gained a whopping 90.6% in the last four weeks. Why will be covered next.

CRDO is going for a full comeback

The chart below shows how CRDO got off to a very strong start in 2023. The stock rose by about 45% in early 2023, but that changed on February 15 when the stock fell off a cliff after CRDO lowered its outlook for FY2023 and FY2024. The revised outlook sees much less revenue than previously expected due to lower demand from a key customer.

As a result, CRDO expects zero growth with FY2024 revenue staying flat YoY. In contrast, some estimates were expecting FY2024 revenue to surpass $300M or double the $152M in revenue in the first three quarters of FY2023. The stock fell almost 47% in response, wiping all its gains for 2023 and then some.

CRDO stock continued to set new lows until it reached a 52-weeks low of $7.20 on May 4. However, the stock has since gone almost parabolic by closing at $13.72 on May 26, which represents a gain of 90.6% in just over three weeks. The stock has gained over 25% in the last two days alone. Still, the stock is only up 3% YTD despite the massive rally due to the huge selloff that preceded it. The stock is also very much overbought with an RSI reading at over 86.

Why the moment of truth is drawing near for CRDO

It’s worth mentioning that the recent acceleration in the stock coincided with very bullish earnings reports from NVIDIA (NVDA) on the 24th and Marvell (MRVL) on the 25th. Both of these companies soared higher thanks to upbeat reports, which credited the results to AI. According to these companies, huge spending is being directed at AI, something that could prove to be a powerful tailwind for relevant players, including CRDO as an enabler of high-speed connectivity for hyperscale datacenters.

However, the recent stock rally will soon have a major hurdle to overcome. CRDO is scheduled to release its next earnings report on May 31, which is likely to include the latest outlook from CRDO. This event has the potential to provide additional fuel to keep the rally going, but it could also throw cold water on the rally and send the stock heading in the other direction. Keep in mind that CRDO lowered its outlook previously, which triggered the selloff in February as mentioned previously.

If the recent rally in the stock is any indication, the market is anticipating an upgrade to the outlook from CRDO with an assist from AI-related spending, similar to what NVDA and MRVL have reported. However, there is a chance CRDO could fall short of expectations that may be too high based on how much the stock has soared. The fact that CRDO is not a player in InfiniBand, but restricted to Ethernet could play a role here.

For now, consensus estimates expect CRDO to report a non-GAAP loss of $0.04 per share on revenue of $31.3M in the upcoming Q4 FY2023 report, in line with guidance from CRDO. From the Q3 FY2023 earnings call:

“Now turning to our guidance. We currently expect revenue in Q4 of fiscal 2023 to be between $30 million and $32 million, down 43% sequentially at the midpoint. We expect Q4 gross margin to be within a range of 56% to 58%. We expect Q4 operating expenses to be between $26 million and $28 million. We expect Q4 weighted average diluted share count to be approximately 163 million shares. And finally, we expect fiscal year 2024 revenue to be flat compared to fiscal year 2023.”

A transcript of the Q3 FY2023 earnings call can be found here.

For the whole year, estimates expect non-GAAP EPS of $0.06 on revenue of $183.4M in FY2023. The table below shows the numbers for the preceding quarters, which puts the drop-off in Q4 in perspective. Keep in mind that Q3 FY2022 mostly preceded the IPO on January 26, 2022, which greatly increased the number of outstanding shares. CRDO also had $233M in cash, cash equivalents and short-term investments on the balance sheet as of Q3 FY2023.

Source: CRDO Form 8-K

Recall that CRDO lowered its forecast by calling for FY2024 to stay flat. Accordingly, estimates project non-GAAP EPS of $0.03 on revenue of $183M in FY2024.

“So from a revenue perspective, it should be relatively linear throughout the year in terms of a steady progression. Recall that we stated our -- we expect our bottom to be either Q4 or Q1. Q4 we guided $30 million to $32 million.

So if you kind of view something similar to that in Q1, to get to flat year-over-year, it shows pretty strong sequential growth throughout the year. So we do expect to exit the year at a very high-rate of revenue.”

However, while FY2024 revenue is forecast to stay flat YoY, CRDO did throw the market a bone by stating that it believed the bottom would come no later than Q1 FY2024, followed by sequential growth throughout FY2024 to end the year on a very high note. The market seems to believe this forecast is too pessimistic and CRDO will do better in the upcoming quarterly report, thanks in no small part to changes brought about by AI.

Evidence of this can be found in the decline in short interest. Short interest stood at 8,226K on 2/15 after CRDO lowered its outlook, which declined to 7,264K on 4/28, not long before the stock reached its 2023 low. The latest data shows short interest fell to 6,371K on 5/15, which translates to a short float of just 6%.

The stock rally, which started on 5/4 and accelerated in recent days, seems to have gotten an assist from shorts covering their positions in anticipation of CRDO possibly upgrading the previous outlook. Note that the data has yet to take into account the last two weeks, which suggests short interest could be even lower now, especially with all the stock gains in recent days likely to have induced more short covering.

CRDO is a speculative play

The table below shows why CRDO is bought not so much for where it is right now, but where it could be in the future. At this time, CRDO trades at lofty valuations with a number of commonly used metrics well into the triple digits. For instance, CRDO trades at 259 times forward non-GAAP earnings with a trailing P/E of 114. The belief is that CRDO will grow by leaps and bounds in the coming years, but if it fails to do so with sales staying flat like what CRDO forecast in February, then the stock may be in need of a repricing.

Source: Seeking Alpha

Investor takeaways

Sentiment towards CRDO has undergone a transformation recently. Just a few weeks ago, the stock hit a new low for 2023 and the stock seemed destined to continue its slide. But the stock has come close to doubling in recent weeks thanks to speculation that CRDO could become a beneficiary of increased spending on AI and the infrastructure needed to support it.

The rally has taken place even though the most recent forecast from CRDO calls for zero growth with FY2024 revenue expected to stay flat compared to FY2023. It is anticipated that CRDO will upgrade the outlook in light of the billions companies have announced they will invest in AI. Everything else has taken a backseat.

However, while CRDO could revise its outlook for the next 12 months, which currently sees zero growth, it’s by no means guaranteed. And even if CRDO does upgrade the outlook, there is a significant chance CRDO could fall short of elevated expectations now that the bar has been set so high.

The stock has close to doubled in value in recent weeks, which should please the bulls, but there is danger when a stock gains this much in such a short amount of time, especially when the rally is based mostly on speculation. Keep in mind there is no concrete evidence CRDO is about to grow any faster than what CRDO itself has forecast, which is zero growth in FY2024. The market is looking for something much better, but whether it gets it remains to be seen.

The stock could easily give back recent gains if the market does not get what it hopes for in the next earnings report. The stock is way overbought and with multiples where they are, the stock could have a long way to go before it hits bottom. There is every reason to be cautious now that CRDO will soon add some clarity as to whether all the recent speculation is warranted or not.

I am neutral on CRDO as stated in a previous article. Longs may want to consider taking some or all chips off the table ahead of the Q4 report. The AI-induced frenzy has caused a number of stocks to soar higher, CRDO included. The risk is that while some deserved it, others may not. The answer as to whether CRDO belongs to the former or the latter may be revealed in the coming days.

Bottom line, the moment of truth is drawing near. Much depends on what happens at the next earnings call from CRDO. CRDO has to deliver what the market is looking for to keep the rally going. If it does not, then, with the stock heavily overbought and with multiples in the stratosphere, the stock has nowhere else to go than down.