Tuesday, July 29, 2014

CLFD: When Bad Things Happen to Good Companies

To completely date myself, I have an old copy of Graham and Dodd's Securities Analysis in my bookshelf.  This is the Fifth edition which I purchased in the late 1980s and is heavily dog-eared   I also have the sixth edition on my Kindle.  What I love about these books is they really teach you to focus on the company as a whole, rather than just looking at the top line of the earnings statement. 

In fact, the book places far more emphasis on the balance sheet than most other analysis books out there.  This makes a tremendous amount of sense to me, as it really focuses on how management is going about the business of growing the company. 

This explains why I love companies that have strong balance sheets, which brings me to Clearfield Communications.   This company has a very strong balance sheet, with a current ratio of 5.4 and a cash ration of 2.5.  These numbers are indicative of their performance over the last five years.  And their defensive interval ratio has increased from 147 in 2009 to 187 in their latest annual report.  Return on assets is just as impressive averaging 15% over the last five years.

And earnings have been strong.  In their first quarter they reported strong year over year growth:

Revenues for the three months ended December 31, 2013 were $16,148,000, an increase of approximately 57% or $5,883,000 from revenue of $10,265,000 for the first three months of fiscal 2013.  Revenues to broadband service providers and commercial data networks customers were $15,077,000 in the fiscal 2014 first quarter, versus $8,912,000 in the same period of fiscal 2013.  Revenues to build-to-print and OEM customers were $1,071,000 in the fiscal 2014 first quarter versus $1,353,000 in the same period of fiscal 2013.  General softness in the U.S. telco market was more than offset by a large, ongoing build of a U.S. based existing customer.  Also, international sales increased over 160% compared to the first quarter of fiscal 2013 to more than a million dollars.  In addition, increases were driven in part by new product offerings in the access network that drives fiber closer to the home, business and cell tower (FTTx). Operating results for the first quarter of fiscal year 2014 are not necessarily indicative of results to be expected for future quarters or the entire year, due to variability in customer purchasing patterns, seasonality of the business, and operating and other factors.

And the results from their latest report were just as impressive:

Net sales for the second quarter of fiscal 2014 ended March 31, 2014 were $13,214,000, an increase of approximately 26% or $2,700,000 from net sales of $10,514,000 for the second quarter of fiscal 2013.  Net sales to broadband service providers and commercial data networks customers were $12,170,000 in the second quarter of fiscal 2014, versus $9,563,000 in the same period of fiscal 2013.  Among this group, the Company recorded $2,197,000 in international sales, versus $623,000 in the same period of fiscal 2013.  Net sales to build-to-print and OEM customers were $1,044,000 in the second quarter of fiscal 2014 versus $951,000 in the same period of fiscal 2013.  The Company allocates sales from external customers to geographic areas based on the location to which the product is transported.  Accordingly, international sales represented 17% and 6% of total net sales for the second quarters of fiscal 2014 and 2013, respectively.

So, we have a company with a rock solid balance sheet and strong earnings.  I bet the stock has been rallying, right?

Not really:

Since posting a high of 26.59, the stock has moved lower, closing yesterday at 13.08. 

Let's take a longer look at the chart to get an idea for what's happening.

At the end of 2012, Clearfield was trading between 4 and 5 per share.  For most of 2013, Clearfield rallied very strongly, increasing a whopping 564% from their low of 4 to their absolute high of 26.59.  While I seriously doubt most investors made that much money, there were probably a fair amount that did very well. 

While the earnings reports were very strong, they did miss estimates, although the second miss was by a mere 2 cents.

What's really happening is this: traders and investors who made money in 2013 are unloading their shares, handing them over to the next round of Clearfield bulls.  Let's take a look at some basic, back-of-the-envelope calculations using some of the basic methodology presented by Gann in his book Truth of the Stock Tape and Wall Street Stock Selector to determine when this process might be done.

The company has 13.42 million shares outstanding.  According to NASDAQ, they have a roughly 27% institutional ownership and a 50 day average volume of 190,000.  Let's assume that institutions are buy and hold, meaning the actual effective float is about 9.796 million.  At a 190,000 average volume the complete available float will turn over in 51.55 days which is 2.5 months in trading time (the trading week is only 5 days).  Obviously, it will take a bit longer for the shares to change hands from the investors who purchased during the 2013 rally, so we're probably looking at around 5-6 months for this handoff. 

However, this time calculation is only an estimate.  And, of course, you should keep your eyes on the chart for other potential entry points.  But, assuming that Gann was right, we have a few more months at least of this process.

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