Calix: A Connectivity Solutions Powerhouse With Unprecedented Growth

Thesis

Calix, Inc., (NYSE:CALX) a leading global innovator in cloud solutions and software platforms, is demonstrating unprecedented growth in the connectivity solutions sector. With nine consecutive quarters of revenue increase, continuous margin expansion, and strategic partnerships with Broadband Service Providers (BSPs), the firm is positioning itself as a key player in this market. This article examines Calix's performance, valuation, and potential risks, ultimately recommending it as a "buy," while cautioning investors to balance its stellar growth trajectory with possible overvaluation and other challenges.

Company Profile

Calix, Inc., an innovator that took root in San Jose in 1999, supplies a broad scope of products and services globally, featuring an impressive array of cloud solutions, software platforms, and systems. This firm has carved a significant niche in supporting Broadband Service Providers (BSPs), facilitating them to roll out a range of services. Key among Calix's offering is the Calix Cloud, a tailored analytics tool, purpose-built to discern and tap into potential channels for generating new streams of income. Alongside this, the company furnishes EXOS, a modular component of its platforms, designed to perfectly dovetail with the GigaSpire and GigaPro systems. This particular offering stands poised and ready to be deployed as comprehensive solutions, targeted to meet the needs of both residential and business subscribers of BSPs, amplifying Calix's commitment to drive connectivity on a global scale.

Calix Continues Unprecedented Growth Streak

Last week, in the realm of connectivity solutions, Calix Inc. reported a banner second quarter in 2023. The company, marching to the beat of its self-set performance metrics, demonstrated an impressive growth narrative.

For nine successive quarters, Calix has proven its mettle with rising revenue figures, setting records, and exhibiting an unyielding demand from its solid customer base.

Simultaneously, Calix also displayed its financial acumen by achieving four straight quarters of gross margin expansion with non GAAP gross margin of 52.8% coming in at the high end of the company's guidance range, and an increase of 100 basis points from the previous quarter.

According to management, Calix's relationships with broadband service providers (BSPs), irrespective of their size, have fortified the company's market position. Unlike the legacy providers grappling with credit market fluctuations, these BSP alliances have continued to garner substantial investments. An instance of this is the partnership with ALLO Communication, which reaped a colossal $650 million through green bonds to foster growth.

In another feat, Calix broadened its customer base with the onboarding of its 1000th customer. In doing so, it added 16 novel BSPs and 20 cloud customers, while enabling 15 BSPs to launch their initial managed service under the Calix umbrella. These combined ventures contributed to an outstanding quarter, culminating in a revenue of $261 million and the aforementioned bump in non-GAAP gross margins.

Reflecting its commendable resource and inventory management, Calix reduced its component purchase commitments from $370 million in Q3 2022 to $254 million in the current quarter attributed to the efficacy of its low SKU count platform model, which provides the flexibility of component fungibility across diverse product SKUs.

According to management, with the end of the pandemic-triggered supply chain crisis, Calix's lens is now trained on refining subscriber demand analysis, supplier optimization, process improvements, and cost reductions. Extended silicon lead times persist, but there's an upward trend towards improvement. The company is looking ahead with a forecast of decreasing component supply, and inventory turns reverting to the standard three to four turns in the ensuing six quarters.

Regarding its outlook moving forward, the company is anticipating revenue and gross margin upticks in Q3 and is now projecting an approximate 20% annual growth for 2023. Additionally, the annual non-GAAP gross margin expansion is slated to be between 200 and 250 basis points.

Performance

What jumps out immediately from this data is the company's exceptional growth - amounting to $46,503 compared to the S&P Index's $22,110 (based on a hypothetical initial $10k investment for this medium-term time period). The annualized rate of return (ROR) without dividends is a fantastic 19.68%, dwarfing the S&P's 9.72%.

Valuation

That eye-catching Adjusted (Operating) Earnings Growth Rate of 95.38% is outstanding and it's clear that Calix's operating efficiency is firing on all cylinders (see chart below), which is fueling its robust earnings growth. However, when combined with a rather lofty P/E ratio of 36.93x, investors need to tread carefully. Yes, it's undeniable that strong earnings growth can support a high P/E ratio, but it's also important to ensure the price you're paying isn't overblown.

Interestingly, Calix's normal P/E ratio is a sky-high 71.57x. This could indicate that the market typically values Calix at a much higher multiple, suggesting there could be some room for price appreciation if it reverts back to its normal P/E. But tread cautiously - a P/E ratio this high could also imply a potential overvaluation, unless the firm continues to sustain its impressive earnings growth.

Risks & Headwinds

It's evident that Calix is employing an aggressive growth strategy by infusing substantial capital into strategic investments. They are showing discipline in expense management, yes, but this aggressive investment could be a double-edged sword. If their revenue growth doesn't keep pace with their increased spending, we could see an erosion in short-term profitability. While an appetite for growth is admirable, it is essential for Calix to strike the perfect balance between spending and revenue growth to safeguard its profitability.

The issue of prolonged silicon lead times also gives me slight pause. Silicon, as a vital component of Calix's production, has been experiencing extended lead times. Even though some improvement is seen, the longer these lead times persist, the more strain they put on Calix's production capabilities. Any disruption in meeting market demand in a timely manner could erode customer confidence and revenue growth potential.

Finally, Calix's inventory management strategy is on my watchlist. Over the next six quarters, the company anticipates normalizing its inventory and supplier commitments. It's a rational plan, but any missteps in this domain could lead to significant stock shortages or excesses, adversely impacting profitability and sales. If Calix does not calibrate its inventory in line with its demand forecasts, it could result in inventory write-downs or lost sales opportunities, both of which would adversely affect the bottom line.

Final Takeaway

I would rate Calix, Inc. as a "buy". The company shows continuous growth with nine successive quarters of rising revenue, four quarters of gross margin expansion, and strong customer relationships, signaling a strong and sustainable performance. However, investors must acknowledge the risks of possible overvaluation due to its high P/E ratio and potential headwinds from prolonged silicon lead times and aggressive investment strategy. The firm's exceptional growth rate, robust demand, and improving supply chain dynamics make it an attractive proposition, but due diligence is necessary given the outlined risks.