Electronics and computer component manufacturer Smart GlobalHoldings (NASDAQ:SGH) has been on an impressive run this year. The stock has risen by more than 85 percent YTD. The company’s earnings, however, have faced downward pressure. So, is Smart Global stock a good investment still?
Financials Are a Mixed Bag
Founded in 1988, Smart Global is a designer and manufacturer of specialty computing, memory and data storage solutions.
Key product categories for Smart Global include memory modules for smartphones and computers, server memory components and external flash drives. The company also provides software services for enterprise customers.
Smart Global is currently operating under difficult market conditions that have depressed its sales and GAAP earnings. In the most recent quarterly report, Smart Global detailed $383 million in net sales, a 12 percent drop from the same period in 2022.
Among the more encouraging trends for Smart Global investors is the steady growth of its intelligent platform solutions business.
In the most recent quarter, this segment generated $170.9 million in sales, compared to just $95.3 million a year earlier.
Other categories, however, fared much worse. Sales of memory solutions, for instance, fell from $265.9 million to $148.4 million.
It’s also interesting to note that Smart Global sold off 81 percent of its Brazilian subsidiary business in the last quarter. This sale resulted in a $137.7 million cash injection into the company’s reserves with a second, smaller payment to be made on a deferred basis.
Management intends to deploy this cash toward research and development initiatives in the US, potentially giving Smart Global a future growth catalyst.
Speaking of growth, the company’s positive non-GAAP earnings are expected to contract this year by roughly 11 percent.
On the 5-year time horizon, earnings are expected to contract modestly each year. This does not strictly rule the company out as a good investment, especially for investors who are bullish on the long-term potential of new machine learning and generative AI technologies.
These technologies will require new memory and processing hardware, creating opportunities for manufacturers like Smart Global.
SGH Analyst Ratings Are Upbeat
Even after its recent run, analysts still believe Smart Global has room left to rise in the coming 12 months.
The median target price for SGH based on six analyst forecasts is $33, a 19.7 percent increase from the most recent price of $27.58.
Five of the six analysts also rate Smart Global as a buy, with the final analyst offering an outperform rating.
Turning to Smart Global’s valuation metrics, the company appears to be either fairly valued or modestly undervalued.
At 0.79 times sales and 5.79 times cash flow, Smart Global trades at a marked discount for a profitable company with a strong history of revenue growth.
The company’s forward P/E ratio is currently 10.18.
It’s important to remember, however, that earnings are expected to contract over the next few years.
No Cake Walk For SGH Investors
One of the most pressing concerns for investors is a seeming gulf between Smart Global’s GAAP and non-GAAP earnings.
Although the company appears favorably priced on the basis of non-GAAP earnings, it has posted GAAP losses for the last two consecutive quarters.
While cash flows for the trailing 12-month period remain positive at $4.81 per share, consistent GAAP losses may indicate a tougher period ahead for the company.
In the short term, Smart Global may also be subject to high levels of volatility. As a company that is adjacent to the AI and machine learning space, Smart Global may be caught up in what increasingly appears to be an AI stock bubble.
With the market already showing signs of waning interest in AI stocks, high-growth tech companies could face downward pressure on share prices in the near future.
Revenue growth at Smart Global appears to have reached its peak for the time being. Between 2016 and now, SGH has grown quarterly revenues from $159 million to the present level of $383 million.
However, revenues reached their highest point in 2021 and have been drifting gradually downward since. Next quarter, management projects revenues of $350-400 million, continuing the trend of more or less flat sales.
Finally, Smart Global’s balance sheets could be concerning for investors. Following the cash payment for the sale of its Brazilian manufacturing business, Smart Global achieved a record cash reserve of $401 million.
Even after this, however, the company’s reserve is dwarfed by its $782 million in long-term debt. The total debt-to-equity ratio for Smart Global is 2.41, indicating an excessively high level of debt that could impair future growth.
Is Smart Global Stock a Good Investment?
Smart Global Holdings is in the enviable position of being a technology company that does not trade at sky-high multiples to its cash flows. The company is sitting on a large cash reserve that could be used to develop new products and services. It also operates in niches that are expected to see considerable growth over the next several years.
Despite its seemingly fair valuation, however, Smart Global’s risks simply seem to outweigh its benefits. With revenues flattening and earnings expected to fall for the foreseeable future, Smart Global could be a value trap.
While the stock may have been an excellent value buy before its run so far this year, the current price does not make Smart Global an attractive investment.
Given these factors, investors will likely do well to look elsewhere for more sustainable growth opportunities with less risk. Although Smart Global could be a long-term winner, investors will need to see more concrete growth catalysts before investing in the stock.
If Smart Global can move toward positive GAAP earnings and deploy its newfound cash stockpile effectively, however, it may be a good stock to watch for the future.
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