One of our favorite companies to hate happens to actually be a company we believe is vital to the broadband, fiber optics, and satellite markets. It puts us in a peculiar position because when we find opportunities like this one, the company is usually ultimately going to be obsolete and/or bankrupt. On one hand, we think that this could be extraordinarily profitable, and on the other, we think it could be a little detrimental to the broadband and fiber optic markets. Since we are in the business of making money, and not in the broadband or fiber optic businesses, we are going to take advantage of the opportunity EMCORE Corporation (EMKR) has provided. We have been short sellers of this stock since mid-July 2011 and will continue to short this stock.
Emcore prides itself on its semiconductor products for the solar power and satellite markets and we find the solar market to be a weakness for the company. Although we expect EMKR to rebound in its fiber optics sales and eventually grow in this segment, once again the solar/photovoltaic segment of the company is what will continue to deteriorate. Sales in this segment have dropped 7.3% since Q4 2010. Not only have sales slumped, but the margins in this segment have seen a significant amount of escalating pressure. This segment has been accounting for a growing percentage of total revenues, but this is expected to dissipate as the fiber optics segment makes a rebound in the coming years.
Since Q4 2010, the cost of revenue has jumped from 76% to the recent 91% as of Q4 2011, resulting in extreme margin pressure. Gross profit has fallen to 9% (Q4 2011) from 24% in Q4 of 2010. Selling and general expenses have increased 4% since Q4 2010, yet total revenues have fallen nearly 28% in the same time period. It is evident by this divergence that the increased spending in the SG&A line of the income statement has done nothing (literally) for total sales. As we progress further along the income statement investors should be taking note that the operating income has declined over 300% since last year and net income nearly 300%.
Surprisingly, even though EMKR has a disaster of an income statement, its balance sheet is not bad. Operating liquidity (working capital) finished 2011 at almost $19M - which, while not nearly enough for us to be comfortable with it, isn't devastating. The most attractive feature of EMKR is the non-existent, long-term debt. Inventory turnover has been relatively steady over the last few years (since 2009) and EMKR has a strong current ratio as well.
Our biggest concern for this company isn't that it is going to be bankrupt, obsolete, and therefore worthless. Our main causes for concern relate more to the poor management that is in place, and its disastrous effect on the income statement, as also the lack of innovation we see in the future pipeline. This company will continue to be a short position for us until further notice or until it is able to recover from the crippling after-effects of the Thailand flood disaster.
Additional disclosure: We may add to our short position following any significant strength in the stock price.