What's the idea?
The past decade has been relatively difficult for investors in small-cap stocks as globalization, moderate inflation and low-interest rates have pushed the values of large corporations to new heights. However, it seems that the economic winds have changed their direction. As businesses reorient on domestic production and capital expenditures grow, the US-focused small-cap companies can show impressive results.
Clearfield (CLFD) is a leading manufacturer of specialized equipment for the control and protection of broadband fiber optic networks. The company's solutions are used to connect homes and businesses to networks. Clearfield was founded in 1979 and is headquartered in Minneapolis, Minnesota.
Why do we like Clearfield Inc?
Fiber optic networks are the backbone of several rapidly growing industries, including cloud computing, 5G, and the Internet of Things (IoT). New markets and the transition to remote and hybrid modes of operation have led to unprecedented demand for fiber optic solutions.
Clearfield estimates the US Fiber-to-the-Home (FTTH) market at more than $12.5 billion. According to Research and Markets, the market will grow at a compound annual rate (CAGR) of 15% through 2027. The 5G market is valued at a whopping $200 billion and is expected to grow at a CAGR of 48% through 2030.
Clearfield management notes that increased demand in the target market is not a short-term phenomenon. The increase in new fiber in the next five years is expected to be bigger than in all previous years combined.
One of the most important catalysts for the industry is the significant public investment in broadband infrastructure. The Infrastructure Investment and Jobs Act, signed into law by President Joe Biden in November 2021, provides for available funding of about $65 billion, of which $42 billion is earmarked for a broadband program known as BEAD. The program is expected to be implemented in late 2023 and early 2024.
Clearfield is showing impressive growth rates and is steadily improving its operating leverage.The company’s financial results for the trailing 12 months (TTM) are presented below:
- At the end of the year, revenue amounted to $270.88 million, which is 92.5% more than a year ago.
- Operating profit for the same period increased by 152.9% YoY and reached $63.82 million.
- Net income was $49.36 million versus $20.33 million a year earlier.
- The net margin increased from 14.44% to 18.22%.
- Despite multiple increases in net income, operating cash flow declined from $10.90 million to $1 million.
- Clearfield's free cash flow is deeply negative, due to continued capital expenditures to sustain growth. The figure was -$7.20 million versus -$2.70 million a year ago.
Clearfield’s financial performance
We expect the cash flow to recover, as the decline is driven by an increase in net working capital due to an increase in inventories and account receivables.
The company has a strong balance sheet with total debt of $32.46 million, cash equivalents and short-term investments of $22.45 million, and net debt of $10.01 million, which is more than six times less than the company's annual operating income.
Clearfield trades at a premium on the sales multiple, but discounted on earnings multiples driven by the company's high margins: EV/Sales – 3.87x, EV/EBITDA –15.59x, P/Cash flow –19.48x, P/E –19.44x, FWD P/E –15.25x.
Comparable valuation of Clearfield
The minimum price target set by Roth Capital is $120 per share. In turn, Cowen estimates CLFD at $141. By consensus, the fair market value of the shares is $130.2, which implies a 83.9% upside potential.
Price targets of investment banks
In December, the company announced the sale of common stock worth $120 million, at $100 per share. The proceeds are expected to be used to replenish working capital. On the one hand, raising funds reflects future growth prospects, but on the other hand, it dilutes capital and reduces shareholder value.
There are growing fears about a possible economic recession. A worsening economic environment could affect Clearfield's financials and its stock price.