Credo Technology Group (CRDO) is a proven disruptor within the optical space poised to enjoy a multi-year inflection point. Credo’s broad product portfolio addresses not only the traditional front-end compute market, but more importantly, the back-end serving AI servers, where the content will be 5x that of the front-end compute market.
Importantly, Amazon and Microsoft are its top Tier 1 hyperscale customers. Meanwhile, Tier 2 hyperscalers, along with service providers, are moving to multistage switched networks, where the focus is on power consumption. This is a key area of differentiation and leadership where Credo excels. Through its deep analog and DSP acumen, Credo has successfully optimized the split between analog and digital processing in its designs, allowing the company to provide quick turnarounds for special projects requested by its large customers, at markedly lower price points and lower costs.
After a disappointing start to 2023 - Microsoft cut orders for its traditional compute offering early in the year as the transition from traditional compute to AI accelerated - Credo is now poised to inflect. Credo has multiple new programs ramping concurrently in the coming quarters, which will create powerful top line growth, and in turn, fuel a notable inflection in the company’s underlying profitability.
In the next seven quarters, revenues will double and EPS is poised to increase 5x:
A quick snapshot of its product lines catalyzing this multi-year inflection:
As Amazon and Microsoft begin to ramp multiple new programs in the next few quarters - including a number of back-end AI programs with 5x the content versus the front-end compute - another significant data center customer is close to a big ramp in the forthcoming fiscal year. A fourth is set to follow, soon after. By fiscal year-end, Credo will enjoy a much more diversified client base of four 10%+ customers.
Currently, Credo screens badly. The company will have one more quarter of declining YoY growth before the big ramps begin. But then things are going to explode.
This summer, once the April quarter is out of the way, revenues will grow 132% over two years, operating margins will rise from 6% to 34%, and EPS will inflect exponentially, up 1200%.
That’s great, John. The stock trades for a silly valuation though. Isn’t all the good news already baked into the stock? Fair question, as CRDO does trade for 10x $300M in forward sales. So Yes, CRDO is highly valued. Agreed.
But remember, P/E’s do not drive stock prices. Instead, various studies by William O’Neill & Co. have proven that accelerating revenues and earnings drive stock prices the most over time.
In this regard, we expect Credo’s valuation to eventually rise 50% from current levels to $4.5B’ish in 9 months.
It’s simple math on two fronts.
First, the CRDO’s Institutional Ownership profile is undersized, not just on an absolute basis:
But, ESPECIALLY, on a relative basis. ANET’s Institutional Ownership base is 10x larger:
We expect dozens, if not hundreds, from ANET’s institutional base to be buying into CRDO throughout 2024 and 2025 as growth materially inflects. Hundreds of other new institutions will move into CRDO AFTER the big numbers are reported – buying that we visualize selling into as CRDO heads from $25-$30 in the coming quarters. Remember, in late 2016, ANET was also very expensive. Then it did this:
ANET was certainly expensive entering 2023. That did not stop it from doubling again:
And it’s still going, which is why I am also long ANET entering this upcoming week.
When we go back to 2012-2014, this was ANET’s first set of glory days, before it came public:
In its growth curve, CRDO is at the same point as ANET, when it tripled earnings over two years. You see it above? ANET’s EPS grew from $0.10 in 2012 to $0.31 in 2014.
Credo’s upcoming inflection in revenue upside will flow incrementally to the bottom line as its costs stay relatively fixed, creating a major inflection point in its bottom line. This is the ultimate catalyst for the re-rating we expect to happen to CRDO over next two to three quarters.
After all, a $4.5B market cap is nothing for a company poised to grow revenues 150% in 3 years. That’s only 10x forward sales of $450M for FY’25. What’s more, there is even a case for sales of $550M-$600M in FY’25, which would translate to $52-$55.
1. Credo’s top two customers, Amazon and Microsoft, are set to double their business with the company in the coming quarters. As AI servers continue to proliferate, Ethernet-based solutions will garner additional market share gains from the current standard, Infiniband, due to the myriad of power efficiencies that will manifest via Ethernet.
2. Credo has two additional large customer hyperscalers it will perform back-end and front-end work for in the long-term term.
3. Add in all of Credo’s Tier 2 hyperscaler customers, as well as its nascent product lines which are also ramping up in traditional optical markets (scaling from 50G to 100G, 200G to 400G, and even 800G).
As we look ahead, it is easy to see the significant upside for CRDO over the next 8 quarters.
Not only does Credo have 4 significant hyperscale customers, 10 networking and server OEMS and more than 10 optical module providers as customers, its pipeline of new programs and customer wins continue to stack as well.
So now consider the expansion in revenue opportunities with all the hyperscale customers essentially doubling their CRDO content. It follows that Credo’s revenues can quickly double their previous peak levels from the January quarter, perhaps much faster than the current sell-side numbers?
Observe the current model estimates for Credo to achieve a $100M quarterly run-rate below. I see a much quicker path than the Street, with a $100M quarter viable by the 1/25 quarter:
With high odds that forward numbers will have major upside relative to current consensus, I expect Credo’s revenue and EPS inflection to manifest much more rapidly and powerfully, catalyzing a stair-step move in the stock.
I see $21-$22 by early January, mid-$20s by the spring, and $28-$30 by next fall/early winter.
Clearly, many funds see the same thing we do.
Note how CRDO’s weekly chart has inflected to new all-time highs:
As demand for its disruptive next-gen power-saving AI products inflect, Credo’s revenues and earnings are poised to ramp up exponentially in the next 2-8 quarters. So should its stock price.
CRDO is under-owned relative to Arista Networks. Its shares are in strong demand and should therefore trend higher in the coming months and quarters as its optimal growth curve manifests.
After rising 50% the past few months, I think CRDO will rise 50% over next 9 months. I plan to add more on any dips to the low-$19s and high-$18s early this week.
After digesting a recent secondary in the $17.50 range, the stock is trading 2M shares a day. The selling seems less pronounced with each passing day, creating a compelling entry point.
With $10 of upside over next 9 months versus $1.50 down to our $17.95 stop loss, this trade idea represents wonderful upside asymmetry, adding to our high conviction for the trade.
On a final note, the Opticals group has been incredibly strong of late. ANET and AAOI have been major movers. Now with NVDA and SMCI turning up, the backdrop is perfect for CRDO to outperform, allowing it to punch into the $20s this week.
Have a great week ahead!
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Disclosure: We are long CRDO in the accounts we oversee.
Disclaimer: In no shape or manner should the views expressed in this piece be considered investment advice. We reserve the right to change our positioning in these names at a moment’s notice without updating you on any such change in opinion and positioning.
Investors need to consider their investment risk tolerance before investing in the stock market and also before investing in any of the stocks mentioned in this report.
