Cray Could Provide Investors With Cray-Cray Returns

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Cray's (NASDAQ: CRAY  ) second quarter was good, its third quarter should be better, and subsequent quarters should reveal great things about the company. Hence, there is huge potential for investors in the company.

The optimism about Cray's future arises from two factors. First, the entire High Performance Computing, or HPC, market is growing at an impressive rate, having grown from generating $9.5 billion in global revenues in 2010 to just over $11 billion in global revenues in 2012. That growth rate seems to be just the tip of the iceberg, as many organizations have started seeing real needs for supercomputing.

In one of its studies, IDC, a tech research firm, found that "97% of companies that had adopted supercomputing said they could no longer compete or survive without it."  The rate at which governments of various countries launch projects that need firsthand supercomputing shows just how bright the future is for supercomputing.

The task for investors is to unearth the companies that would benefit the most from the impending growth, which is where the second cause for optimism about Cray arises. Cray has an effective management structure in place, which is enough to position it as a major player in the growing HPC market. Let's briefly look into the things that should make Cray attractive to investors.

Solid business core
One thing that's impressive about Cray is its strong sales pipeline, as pointed out in this article by Evan Niu, a fellow Fool. So far this year, Cray has landed at least 10 new deals, all from big organizations. These organizations include European Centre for Medium-Range Weather Forecasts, Engineering and Physical Sciences Research Council, UK, and Japan's Railway Technical Research Institute, among others.

The fact that Cray has the U.S. government as its biggest customer tells us how strong, reliable, and effective Cray's supercomputers are (Cray generated more than half of its 2012 revenue from the U.S. government). All these are made possible because Cray has identified its competitive strengths and leveraged them well. Cray knows its strengths lie in data analytics, storage, and manufacture of enterprise-class systems.

Looking forward, the opportunity is even greater for Cray, with IDC forecasting that global economy in HPC will grow by about 7% each year over the next five years. As more supercomputing is done, the need for analysis and data storage will be greater (this is one of Cray's biggest strengths). IDC believes that storage and management of data is one of the major challenges of HPC, and Cray is in a position to maximize this niche.

Cray is equipping itself to solve this problem, as it hired a number of key individuals from SystemFabricWorks in 2012, a move that gave birth to the complete Lustre storage for X86 Linux clusters, launched in June. The product gives Cray a competitive edge in the HPC storage space. The product is a stand-alone storage product, so customers don't have to buy a Cray supercomputer before they can access Cray's expertise in Big Data.  

Solid business core evidenced by growing market share

The biggest reason for this increase is that Cray sets its focus on the high-end supercomputing market, leaving the low-end market to big players like International Business Machines (NYSE: IBM  ) that have the financial strength to produce in large quantities. However, that is not to undermine the affordability that comes with its products designed for mid-sized organizations. Cray's XC30-AC is an example of this affordability. A single cabinet of the supercomputer costs $500,000. Since the need for supercomputing is constantly increasing, affordability will be key in determining who stays on top.

Another thing that plays to Cray's advantage is that it maintains quality even as it tries to make supercomputing affordable to everyone. According to an IDC analyst, other makers also try to bring down cost, but those manufacturers tend to use different components than their top-of-the-line machines. 

It's worthy to note that the deal Cray sealed with ECMRWF is a kind of steal, since IBM has been providing the facility with supercomputers since 2001. This illustrates how much Cray is leveraging its strengths.  That deal means Cray will gain some market share ground against IBM. Calculating from IDC's forecast of 7% growth and the company's revenue expectations of $520 million, Cray's market share growth this year will be around 50%.

Cray's attractiveness isn't entirely aided by the boom of the HPC market. Consider Silicon Graphics International (NASDAQ: SGI  ) , the company that Cray overtook in terms of market share in 2012. The reason for comparing Cray with Silicon Graphics is that both companies look to leverage the vast opportunity in the data storage market. Silicon Graphics has a customer base larger than Cray's.  Additionally, a comparison of revenues suggests that Silicon Graphics' customer base is larger.

CRAY Revenue Quarterly Chart

CRAY Revenue Quarterly data by YCharts

However, despite the fact that Silicon Graphics has a broader customer base, resulting in more revenue, Cray seems to be more efficient in management. A comparison between the operating margins of both companies shows this:

CRAY Operating Margin Quarterly Chart

CRAY Operating Margin Quarterly data by YCharts

Bottom line
Currently, Silicon Graphics looks better, but the stock has been relatively flat, while Cray has had more occasions on top. Cray's rise and fall is because its business has been somewhat seasonal. But, with impending growth in the industry, that should become stable over time. 

Comparing gross profit margins give a clearer picture. Despite generating higher revenue, Cray keeps more of its revenue than Silicon Graphics. Deducing from the chart, Cray kept about $0.32 out of every dollar it generated last quarter, while Silicon Graphics kept just $0.27. While Silicon Graphics' customer base should play to its advantage, a more effective management makes Cray the winner.

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Read/Post Comments (2) | Recommend This Article (3)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On November 09, 2013, at 11:01 AM, rsinj wrote:

    I would be more than a little concerned with your statement that Cray generated more than half its 2012 revenue from the US government. Don't you think investors should be as well? Might there be some downward revisions/surprises coming because of the government shutdown, sequester, and overall budget cuts?

    Historically Cray has gone from feast to famine. Is there any reason to think things are so different this time?

    I see that earnings estimates for FY 2013 are extraordinarily dependent on a strong December quarter. First three quarters are showing a loss of 61 cents/share assuming they meet the 12 cent/share loss estimate when earnings are announced on Monday. How they go to a profit of $1.10/share in December quarter is curious - even considering that Dec 2012 was 41 cents/share. The analyst consensus of 62 cents/share for FY 2013 makes no sense either - since through the first three quarters (again assuming a meet on Monday) would mean they'd need $1.23 for December quarter.

    I think there's much more opportunity for Cray to disappoint to the downside over the near to medium-term rather than surprise to the upside.

  • Report this Comment On November 11, 2013, at 7:57 PM, rsinj wrote:

    And as indicated in the earnings release after market close today, they missed analyst estimates by a country mile both on top line and bottom line.

    Top line revenues were 54 million while estimates were for 90 million.

    Bottom line earnings estimate was for a loss of 12 cents/share while the company turned in a loss of 29 cents GAAP and a loss of 35 cents non-GAAP.

    So, thus far, with 3 quarters for 2013 in the books, the company is at a loss of 71 cents .

    I don't think there's any question at this time that they do not come anywhere close to the 62 cents/share estimated profit for the year - they'd need profit of about $1.35/share in Q4 - not going to happen.

    One has to ask "how did the company miss by so much" or "how did analysts get it so wrong"? My first inclination would be to say it's a disaster, but looking at 2012 revenues in the quarter, 2013 was up over 50%. But at the same time, they only lost 14 cents/share last year in the quarter compared to the loss of 29 cents this year.

    Look for estimates to come down significantly over the coming weeks, and if the analysts have any morals or integrity/honesty, they will downgrade the shares significantly.

    The shares more justly be trading somewhere in the $10 to $15 range based on the earnings report and what we can expect in Q4. Anything over $20 is too expensive.

    There will be the tax loss selling and fund window dressing taking place next month, so that should move the shares lower closer to where they should rightly be.

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