You can please some of the people some of the time, but apparently, you can't please momentum investors all of the time. That's the lesson we learned from ceramics specialist Ceradyne (NASDAQ:CRDN) this week, as it reported earnings that exceeded expectations, but apparently not by enough to maintain the stock's upward momentum -- a momentum that has returned better than 50% profits to investors over the past year.
Ceradyne reported its Q2 results yesterday morning, and despite posting 14.4% sales growth -- and earnings-per-share improvement that was twice as large -- the stock is now down 9% and counting. Why? That's what we're here to find out.
Slowing growth
The first negative that jumps out at you from the report is the difference in growth rates between Q2 and the first half as a whole. Don't get me wrong -- 14% sales growth and 29% profits growth are outstanding -- but when compared to the 25% sales growth and 41% profits growth posted year-to-date, they do give the impression of a business that's slowing down, rather than accelerating as momentum investors had hoped.
Slowing prospects
Also worrisome to the mo-mo crowd, I suspect, is that the company seems to be burning through its backlog rather quickly. For example, in Q2, it recorded $185.4 million in sales, but replenished fewer than one dollar in three with new contracts. "New bookings" in Q2 amounted to just $55.3 million. And the fewer contracts on the books waiting to be fulfilled, the less revenue that will turn into profits in future quarters. (For more on the importance of backlogged orders, read "Say What, SAIC?" In that article, I look even deeper at the issue, discussing the relative importance of "funded" and "unfunded" backlog at defense industry peers like Boeing (NYSE:BA), General Dynamics (NYSE:GD), Raytheon (NYSE:RTN), and Northrop (NYSE:NOC) -- and yes, SAIC (NYSE:SAI), too.)
Accelerating plans
Yet far from being surprised or alarmed over these developments, management has been aware for some time that its Iraq war-fueled growth won't last forever. Rather than lament the apparent slowdown in new body armor orders, CEO Joel Moskowitz instead focused on where Ceradyne is going to find its next growth spurt: ceramic products for the solar power and nuclear power industries, and, returning to the military well, its new "BULL" mine resistant ambush protected vehicle, which is angling for "MRAP II" contracts on offer by the U.S. military.
My take: Considering the evidence of slowing growth, investors can be forgiven for taking some profits off the table at this time. For my part, though, I think Ceradyne's prospects still look Ceradyne-o-mite!
Ceradyne isn't a recommendation of Motley Fool Rule Breakers, but we've got companies invested in solar power and military defense that are. Find out who we like even better than Ceradyne when you claim a free 30-day trial to the service.
Fool contributor Rich Smith does not own shares of any company named above. SAIC is an Inside Value pick. The Fool has a disclosure policy.
