Clearfield: Unraveling Fiber Fortunes, A Hazy Path Ahead

Summary

• Clearfield, Inc. negatively surprised investors with reduced revenue expectations. So, what's next?
• Clearfield's revenue growth rates have been disappointing, and the company's profitability profile is deteriorating, with lower gross margins projected for the future.
• I make the case that, while Clearfield, Inc. stock has recently dropped by 20%, I don't believe this implies that the stock is undervalued.
• Looking for a helping hand in the market? Members of Deep Value Returns get exclusive ideas and guidance to navigate any climate. Learn More »

kynny

Investment Thesis

Clearfield, Inc. (NASDAQ:CLFD) is a fiber optic company. In my previous article, as we headed into the earnings result, I stated:

The core issue here is that investors are struggling to figure out what's the sustainable growth rate for Clearfield.

Then, on top of that, Clearfield recently diluted shareholders to bolster its cash reserves.

A month on from that statement and Clearfield stock is down 20%. So, what's next? I make the case that just because the stock is down 20% since I wrote those words does not mean that Clearfield stock is undervalued.

I continue to believe that investors would do well to avoid this name.

Revenue Growth Rates Fizzling Out

Clearfield manufactures fiber management and connectivity solutions for telecom customers, simplifying their fiber optic network and enhancing network performance.

CLFD revenue growth rates

As noted already, as we headed into the earnings results, investor expectations were misaligned with Clearfield's prospects.

See below Clearfield's guidance:

CLFD Q1 2023

Now, after Clearfield's fiscal Q2 2023 results, Clearfield's updated guidance points to $275 million.

CLFD Q2 2023

As an investor, your job is to attempt to get a feel for the long-term prospects of the business and seek out a bargain by paying less than the business is worth.

Put another way, as an investor you demand a margin of safety that leaves you with potential upside potential.

But if management itself struggles to figure out the medium-term prospects of the business, then the business is too volatile. And, by extension, as an investor, you require an even wider margin of safety.

In my previous article, I concluded by saying

[...] allow me to state from experience, that cheap stocks can get a lot cheaper. Particularly once management starts removing their guiding metrics, such as disclosing their future backlog figures.

As you can see from the quote above, I made the case that investors could have seen that Clearfield's prospects were deteriorating, since management sought to remove any insights into its future growth prospects, namely its backlog figures.

Why remove the backlog figures? Because it's a leading indicator of future growth. If the backlog figures didn't look compelling, investors would be less inclined to pay a high multiple for the stock.

With this context in mind, consider management's quote from the earnings call (emphasis added):

[...] throughout the pandemic, our customers ordered products earlier in their deployment schedule to stay ahead of any supply chain challenges. This just in case approach particularly at our large regional service providers, led to growth in our backlog, which reached record levels by the end of fiscal year 2022.

Here management notifies investors that the business went through a period of over-earning in 2022, and now there's a lull in its revenue growth rates. Next, we'll discuss Clearfield's underlying profitability.

Profitability Profile Turning South

CLFD Q2 2023

When asked on the earnings call about Clearfield's gross margin profile for H2 2023, management stated that the next couple of quarters would see a sub-30% gross margin profile.

Given that in the same period a year ago Clearfield was reporting approximately 40% gross margins, for the business to be reporting less than 30% just twelve months later doesn't appear to reflect a business that has stabilized.

The Bottom Line

At the surface level, Clearfield, Inc. investors may believe that the stock is cheaply valued, since it is priced at approximately 17x this year's non-GAAP EPS figures.

However, I contend that until Clearfield stabilizes its operations and returns to top line growth, its gross margin will remain under pressure.

Meaning that until investors regain confidence in Clearfield, Inc. prospects, the multiple that investors will be willing to pay for this stock will remain compressed.

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.

Comments

[FTTH investment guru]

COMM getting destroyed today. Does not bode well for CLFD. Probably another 9-12 months out before recovery

[APB]

No way of knowing what Thursday will bring. BEAD funds probably started flowing in July, but no idea how that impacted CLFD to date. Guidance will be crucial but I am sure management will have a tough time estimating BEAD funds in their numbers. Would not be surprised if they continue to leave this funding out of their numbers for now. Will the path remain hazy? Is doom around the corner for the stock which the author indicates is quite overvalued even in the 30's?

[thewideopenroad]

Looking to buy this stock, so not trashing. After a gigantic downturn, it is still not cheap! Are these estimates right? $1.85 for '23 and DOWN (?) in '24 to $1.63? 25x and 29x, respectively?

Now, the analysts have gotten the estimates wrong. But, to be fair, Management has gotten estimates wrong too! (Which is worse to me).

I think Management is pretty good and honest. I just think they have no visibility into their business. Anyone have a good feel for how this quarter is going to shape up?

[Integr8byDarts]

@thewideopenroad I remember them saying you wouldn't see good quarters showing up in earnings until next year, just based on when they anticipated orders coming back in (late this year). That being said, they did a poor job predicting the downturn and my bet is they will do just as much of a poor job predicting the upturn. Now that BEAD funds are getting allocation decisions by state, perhaps business might start looking up again.

[Skagit]

@Integr8byDarts

I think to restore credibility in their forecasts, they should refuse any BEAD funding until 2024. :)

[APB]

State allocation of$42.5 billion in fiber build funding was announced on June 26. Go here broadbandusa.ntia.doc.gov/... and click on News in the menu.

[ChrisForte]

@APB Lets hope the money is dispersed and put to work in a reasonable amount of time AND the major carriers can find enough workers to do the installations. Having enough able and willing bodies to perform the work is a bottleneck.

[APB]

CLFD continues to outpace SA peers on high volume.

[theunintelligent-investor]

@APB Is this related to the BEAD funding that will be released end of month?

[APB]

@theunintelligent-investor Very possible. If it is then investors are looking past the current quarter and therefore guidance for the rest of the year might trump whatever they report for earnings and revenue.

[Skagit]

@APB

The use of the SA generated "peer group" is often misleading. If you were to do a search for Clearfield's competitors, you'll probably get 6 lists with different companies on each one. They design and sell broadband connective solutions, so does that make them similar to netgear? You might see Algoworks, an Indian software company or Molex, a computer hardware supplier for power distribution.

SA's supplied list for competitors to Microsoft includes Oracle and then a cluster of security software companies because MSFT is also in the software biz. But security software can have a great or terrible day and it doesn't really affect MSFT much at all.

Some comparisons are easier to make. Restaurant Brands Inc. owns Burger King and other smaller chains and compares pretty easily with Wendy's. How do they stack up against Cheesecake Factory - a horse in a different race?

With Clearfield, the question is not how someone else is doing unless you can find another public company in nearly an identical situation. The question is how soon will some of this money be ladled out and what happens after that? Do they morph into something else? Will there be another technology to replace current broadband? Oil and gas companies are always on the prowl for more assets because their daily extraction limits how long they can stay in business. Clearfield will need a plan to replace this connectivity push because it likely will not repeat.

[APB]

CLFD is up 27% since this article was written. Percentage change for SA listed peers over that same time frame are as follows:

ADTN 3.5%
ITRN 6%
RDWR 6%

[APB]

@APB SA listed peer RBBN is down 5%.

[Xxfactor]

@APB Totally misleading since CLFD is coming of an epic collapse

[APB]

CLFD stock is up about 20% since this article was posted. Also, it was reported that a director bought 5,000 shares.

[La Madre de todos los Krakens]

@APB where is it reported?

[APB]

@La Madre de todos los Krakens Go to your brokerage on-line site and check the SEC filings. I believe it was reported on June 2.

[Integr8byDarts]

@APB Just seems to be a broader small-cap rally; I see no specific catalyst for CLFD yet other than being viciously sold off.

[Nostradamus' Calculation]

We closed the first gap to the upside. It feels like we have really turned a corner and going into the second half as we see more infrastructure spend this is a great buy again

[thewideopenroad]

What happens to BEAD in the debt ceiling deal?

[Xxfactor]

@thewideopenroad Not sure what bead is but the infrastructure bill is intact

[Integr8byDarts]

@Xxfactor First, nothing will happen to existing spending packages like the Infrastructure Bill or Inflation Reduction Act, so nobody needs to worry about it affecting CLFD.

Next, let me give a brief breakdown of the federal subsidies. First, within the Infrastructure Bill, there is $65B allocated to broadband. Of that $65B, $42.5B is allocated to rural broadband, and this is the BEAD program, or 'Broadband, Equity, Access, and Deployment'. No money from BEAD has been disbursed yet, and probably will not be until 2024.

Then, there is the Rural Digital Opportunity Fund (RDOF), established by the FCC, which has $20.4B remaining to be distributed over the next 10 years. One auction in 2020 occurred, with $16B funding offered, but many of the winners (Charter, SpaceX, LTD Broadband) got their plans approved by the FCC. Only $9.2B of that $16B was disbursed and much of that money hasn't technically been given out pending approval of plans.

Assuming BEAD and RDOF release their funds the next 10 years at a constant pace, that's about $6B a year for rural fiber. For context, AT&T spends $3B on fiber a year.

I sourced all of this from the Inbox-Alpha write-up on Clearfield I had shared earlier. Once again, it's worth giving a read.

[Integr8byDarts]

@Integr8byDarts Typo: Many of the winners got their plans *denied* not approved.

[Xxfactor]

Appreciate your analysis. I can't believe how this thing rocketed all of 2022 when everyone else was getting killed.

I didn't realize what was happening and missed a 3x profit I was literally ready to hit the button on but didn't.

Im holding my shares and added at the worst time but not expecting much here for a while if ever.

Management really made some haters the last 8 months or so by their actions. Who knows if they can ever recover.

No matter what kind of investor you are you really need to analyze the situation as much as possible before selling or not selling when you have big profits

[Skagit]

Hi Michael,

Seattle had an outstanding rookie baseball player last year. This year, his batting is unimpressive but, like CLFD, everyone expects the magic to return sooner or later. As an investor that prefers some notion of timing, I agree that I need to hear the good news from Clearfield that they are back on track. Otherwise, we're just twiddling our thumbs and there are too many opportunities to allow that.

[Integr8byDarts]

@Skagit I think the stock is dead for another quarter (or two), but long term holders will be fine--assuming you didn't buy in at the absolute top. [Sitting here with $59 cost basis--it hurts, but I can wait]

[Skagit]

@Integr8byDarts

I left when their guidance was for single-digit growth. Like you, I can wait but I wait for dawn, not trying to find out how long night will be. Everyone has their own style - yours often works out fine. The stock we've held the longest - Trane Technologies - is up an astonishing amount but ain't been much to brag about this year.

[Xxfactor]

@Skagit Trane is solid ill have to check it out