The technology sector is in a constant state of flux with new technology superseding traditional modes of production. Information Technology is one of the fastest growing sectors of the world covering industries ranging from semiconductor design and production to hardware manufacture. The S&P 500 Information Technology Index went up by 9.94% over the last year. The dividing line between traditional supercomputing and big data continues to blur as a new era of supercomputing technology emerges. With growing IT infrastructure comes a need to handle information data and computing. That's where companies like Cray Inc. (CRAY) come in.
In this article, I will discuss the upside potential of CRAY, a small cap stock, by analyzing the future market trends and growth prospects. Cray stands at a center point ready to take advantage from increased demand for its products.
What The Company Does?
Cray Inc. designs, develops, manufactures, markets and services high-performance computing (HPC), systems, including categories of systems commonly known as supercomputers and/or clusters, and provide storage solutions, software and engineering services related to HPC systems to its customers. Its operations are dependent upon government agencies and government-funded entities, academic institutions and commercial entities.
The product portfolio of the company is focused on two broad markets namely supercomputing portions of HPC and Big Data that deals with storage and data analytics. Other than that, it provides a range of service offerings centered on those products thus leveraging its customer base. Its recent development by the name of "Adaptive Supercomputing" vision integrates its hardware and software systems. In the last quarter, it introduced its Aries-based XC30 supercomputers in the HPC segment. Products launched in HPC segment rely on government support and scientific discovery. Hence seasonality is one of the characteristics of its products. YarcData caters to the Big Data segment by extending supercomputing platform to graph analytics problem. An increased demand in this segment can be anticipated as the IT sector undergoes an augmenting trend.
The company generates revenues from two prime sources mainly Products and Services. The former contributed around 84% to the total revenues standing at $353 million in 2012. Service segment shows a declining trend as the company concentrates on its product portfolio. Revenue grew across all product lines backed by an increase in product offerings from top to bottom. It increased its addressable market last year by maintaining a competitive position. Last year, around 15% of the revenues came from its growth initiatives exceeding expectations by 50%.
The management seems confident about the company's future earnings as it anticipates the trend to continue. Estimated revenues for 2013 amount to $500 million. Second quarter revenues are expected to touch $80 million followed by an increasing trend.
The previous year proved to be an outstanding year for Cray as its earnings hit record high amounting to $421 million. Revenue increased by 78% year-over-year and net income went up to $161 million. However, the growth in earnings over the most recent quarter was not as impressive as the last year. As stated earlier, the decline can be attributed to seasonality in its earnings. For a company like Cray, fluctuation in earnings is a feature of the industry it operates in where product launches can lead to a sudden surge in earnings. EPS for 2012 stood at $4.27 despite an increase in the number of outstanding shares.
A strong asset base is a prerequisite to survive in this volatile climate. The company has shown a continuing increase in its asset base with total assets amounting to $510 million, a sharp increase of 80%. Breaking down the balance sheet composition reveals an increase in both its equity as well as debt. However, the increase in asset base was financed through organic growth. Liquidity position of the company improved tremendously as it was able to generate free cash flows during its 5 years of operations. All in all, the financial statistics of the company seem robust and sustainable.
Given the increase in demand for supercomputing and growth prospects in the Big data segment, now would be the right time to expand its operations. The management plans to exploit this favorable trend to maintain its competitive position in the industry. Analysts expect growth rates to touch 7-8% in the computing industry while the company has kept its target growth rate at 15%. For this purpose, it undertakes a dual strategy to expand its business mainly through acquisitions and an increase in product offerings. In November, it acquired Appro International, Inc., a merger that cost the company $25 million. The acquisition will expand its product portfolio in the HPC market and leverage its global sales worldwide. Alongside, it has gradually increased its capital expenditure. In 2012, capital expenditure stood at $11 million, an increase of 120% year over year.
The management increased its product offerings substantially last year, returns from which will be materialized this year. Its recent mix of Apache Hadoop software with its CS300 line of supercomputers will help in data storage and analytics products. Furthermore, it just completed its largest R&D project CrayX300 in the HPC market. The management is confident that the latter will help increase its market share in the next few years. Thus, the company strengthened its position in both in segments.
Investment in research and development is integral to survive as a player in the computing industry. Last year, funds allocated to this segment attributed around 15% of the total revenues. Through research and development, the management aims to track the new trends and technologies and adjusting its product portfolio accordingly. Thus the management's dedication to its growth initiatives seems to be a calculated one.
Cray operates in a highly competitive environment facing competition from global giants as well as some small players. In the Big Data segment, Silicon Graphics (SGI) is one of the major competitors for the company. In the HPC segment, competition is even more intense with companies like Dell Inc. (DELL) and Hewlett-Packard (HPQ) giving the business a run for its money. However, it is able to maintain its existing market share through more diversified products and its high-end supercomputer market segment. Its energy efficient technology and flexible software systems gives the company its competitive edge. Side by side, its net profit margin stands at 58% while the industry average falls considerably behind at 38%. Its high net margin gives the company the chance to reinvest its current earnings into the business.
One of the biggest threats to the business is the highly competitive environment it operates in. Giants like Dell and Hewlett-Packard have the power to compete at prices to its brand loyal customers making it difficult for Cray to operate on an equal footing. To maintain a stronger hold over the market, it increased sales and marketing expenditure by 42% last year. Another caveat to this stock is its reliance on small number of projects making its operational earnings extremely vulnerable to changes in demand. Its investment in the defense sector seems to have a bleak future with future defense cuts in the pipeline.
CRAY is currently trading at $19.62 with a total capitalization of $772.7 million. In the last three months, the stock price has ranged from $16 to $23, a standard deviation of approximately 23%. The stock price has shown an incremental trend as investors warm up to this small cap growth stock. The EBITDA till date amounts to $155 million approximately. Given the management target of 15% growth rate, EBITDA is expected to reach $178 million by the end of this year. Again, the EBITDA for each quarter varies greatly for reasons mentioned earlier. The 1st quarter of 2013 did not fare well, but with the expectation of increase in revenues, an increase in EBITDA will follow. The P/E ratio stands at 5.3 with the ratio projected to reach 32 in the near future.