Cerence: Buy The Drop On This Fast Grower

Summary

• Cerence continues to execute well, and is seeing strong adoption trends.
• It has strategic partnerships in place, and expansion into the two-wheeler market presents another growth avenue.
• It maintains a well-funded balance sheet, and the recent drop in share price presents a buying opportunity.

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Even growth stocks need to take a breather every now and then, and unless the thesis is busted, these dips present opportunities for new and existing investors to layer in. Such I find the case to be with Cerence (NASDAQ:CRNC), which has seen material share price weakness in recent months, falling from the $120-level reached in August to $86.92, at present. In this article, I highlight why this may be a good buy-the-drop opportunity, so let’s get started.

Why CRNC Is A Buy

Cerence is a technology company that’s specialized in building AI-powered virtual assistants for connected and the emerging autonomous vehicle categories. Its products include voice recognition and natural language technologies, and have been included in 400 million vehicles to date. Cerence’s technologies are backed by over 20 years of expertise, and it’s well-positioned to ride the wave of smart cars entering the marketplace.

This is supported by remarks from Volkswagen’s (OTCPK:VWAGY) CEO last month, in which he remarked that smart cars, not electric cars, will be the game changer for the automotive industry for the next decade and beyond. Meanwhile, it appears that CRNC is not getting much love from the market in recent weeks, as its share price has seen a double-dip of sorts from the $120-level in August. As seen below, CRNC now carries an RSI score of 27.7, indicating that it’s in oversold territory.

(Source: StockCharts)

I see this as being the result of a double-whammy for CRNC. For one thing the tech sector has seen a broad recent sell-off over the past couple of weeks. In addition, there have been renewed concerns around the automotive sector due to chip shortages, and this is reflected by the 26% YoY decline in auto sales during the month of September.

While lower auto sales pose as a near-term risk for CRNC, I don’t see this as being a long-term threat, considering that risks are around supply and not demand. In short, I see this as being a good problem to have, as the chip shortage reflects growing consumer demand for smart devices, including smart cars.

As with any imbalance between supply and demand, the pulling forces of demand (driven by higher prices) should encourage a production ramp in microchips, which should move the market towards equilibrium, however ephemeral that may be. Plus, the investor community doesn’t appear to be concerned around automotive stocks, as Ford’s (F) share price is actually slightly up from where it was trading in August.

Meanwhile, CRNC continues to post impressive results, with revenue growing by 29% YoY during the third quarter (ended Jun’21), and profitability exceeded management’s expectations, with gross margin landing at 75%. This resulted in faster bottom-line growth, with adjusted EBITDA growing by 40% YoY. These strong results were driven in part by continued momentum around adoption. As seen below, MAUs are now approaching 12 million, and the number of customer interactions also continues to grow.

(Source: investor presentation)

Plus, CRNC is seeing a record number of SOPs (start of production) and has signed strategic partnerships with SiriusXM, Harman, and with Visteon, for two-wheeler business with a major motorcycle manufacturer. In essence, CRNC’s goal is to be the central AI brain of the car, and to be the driver’s trusted co-pilot, and the partnership with Visteon opens up a new world of opportunities for CRNC in the motorcycle market (driven by hands-free helmet technology). Management is also being strategic in tech-neutrality, as noted by the CEO during the Q&A session of the recent conference call:

We're trying to be sort of neutral to various different ecosystems, because we're very focused on supporting Google or Amazon or Apple in their ecosystems, the big tech ecosystems that we know of here, or any custom ecosystems that may be coming on board with companies. HARMAN Ignite Ecosystem is one such example that I referenced to in my remarks.

But again we're not just stopping to that. We're also working closely with the Chinese ecosystems as well. So the way we're trying to approach this is, we're not trying to build a competing big tech ecosystem. Instead, we're trying to be compatible with the big tech ecosystems, which are out there and also support any custom ones that the OEMs may want to support.

Cerence maintains a strong balance sheet to support its forward ambitions, with $150M in cash on hand, and a net debt to EBITDA ratio of 1.39x, sitting well below the 3.0x safe benchmark that I use. I also see value in CRNC, especially after the recent drop in share price, at the current price of $86.92 with forward PE of 37. This is considering the CRNC’s industry-leading position, and the 13-22% annual EPS growth that analysts estimate over the next 2 years.

Analysts have a consensus Buy rating on CRNC with an average price target of $138, implying a potential 59% return from the current price.

(Source: Seeking Alpha)

Investor Takeaway

Cerence continues to show strong growth and has plenty of growth runway, especially as it expands into the motorcycle market. While the market has given pause due to perceived risks around chip shortages, this can also be seen as a silver lining as a reflection of strong consumer demand. Meanwhile, the company has strong strategic partnerships and maintains a strong balance sheet to fund growth. I see the recent drop in share price as being a buying opportunity for potentially strong long-term gains.

Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

This article is for informational purposes and does not constitute as financial advice. Readers are encouraged and expected to perform due diligence and draw their own conclusions prior to making any investment decisions.

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