Calix: Equity Risk Increases With Overvaluation (NYSE: CALX)

Calix Corporation (NYSE: CALX) since I first reported on the stock in 2020, it has performed very well. Since 2020, the stock has risen from single digits to its current price of $70.Although I still see strong growth for the company for many years to come, and Calix’s high valuation and overbought condition are worrisome. Current investors should consider withdrawing some funds to lock in profits, while potential investors should probably wait for a more attractive entry point.

Calix provides cloud and software platforms and related services globally. The company’s solutions enable Broadband Service Providers (BSPs) to offer a range of services. In short, Calix’s products provide critical analytics that enable BSPs to increase revenue by increasing subscriber numbers and customer loyalty. This may be something that is needed on a regular basis. Therefore, I am bullish on the company in the long term but cautious in the short term. The possibility of a recession next year adds to my concerns.

Currently overvalued

As we can see from the chart above, forward P/E ratios were significantly higher than average in the 1960s. The forward P/E ratio for the S&P 500 (SPY) is 16.6. Calix stock probably won’t fall as low as SPY’s P/E ratio. However, I do think it will likely come down from these valuation levels as higher interest rates lead to slower economic growth over the next year or so. There may be a short-term rally in the broader market, but we are still in a bear market and the overall price of the major indexes is likely to be lower next year. Higher interest rates could slow the economy to recessionary points.

We can see what happens to Calix’s valuation when the P/E ratio rises to a similar level in January 2022 and then falls to a more reasonable level in the summer of 2022. Shares fell from a 52-week high of $80 to around $32 during that time. I think something similar is likely to happen next year.

Economic indicators fell

Declines in key macroeconomic indicators have raised the risk of a recession next year. That could lead to more stock market declines, which could lead to a drop in Calix’s stock.

The housing market has been deteriorating, and higher interest rates have made mortgages less attractive. The chart below shows the decline in existing home sales in 2022.

The next chart shows the decline in new home sales over the past 2 years.

A downturn in the housing market tends to cause a domino effect across the economy. Of course, this usually causes the stock market to fall. As we saw during the stock market decline earlier this year, Calix could be caught in a market sell-off due to its high valuation.

Calix may also see business decline during recessions as BSPs may cut investment/spending during uncertain economic times. The above-average valuation puts the stock at higher risk of a sharp downside.

overbought condition

The weekly chart for Calix above shows the stock’s positive momentum since July. However, the RSI indicator at the top of the chart rose above 70, leaving the stock overbought. Of course, the stock could still rise if the current rally continues. With recession risks still lingering and we’re still in a bear market, this rally may not last.

The last time Calix was overbought on the weekly chart, the stock lost more than half its value in the first half of 2022. So it’s not unreasonable to think something similar could happen soon, especially given how volatile the broader market has been.

positive side

Calix reported a positive quarter for the third quarter of 2022. The company’s revenue grew 37% and RPO grew 65%. RPO represents revenue allocated to remaining performance obligations, which is contract revenue that has not yet been recognized (deferred revenue that will be invoiced and recognized in future periods).

The company’s growth was driven by BSPs offering broadband as a service. This means that BSPs offer more than just standard broadband services. These BSPs also provide email, domain registration, web hosting, and browsers/packages. By offering these additional services, BSPs can better grow and retain subscribers. Calix helps them do this through the company’s products.

Given the positive quarter and guidance in the fourth quarter, Calix is ​​on track for its third straight year of 25% revenue growth. Calix expects earnings to grow 20% annually over the next 3 to 5 years. Revenue is expected to grow 22% next year. However, given the company’s high valuation, that positivity is likely to be mostly reflected in price. If Calix misses expectations or reports unexpectedly negative news, the stock is at risk of a sharp decline.

Near-term and long-term outlook for Calix

In the long run (looking 3 to 5 years into the future), I am positive about Calix. BSPs may use Calix’s products to help increase and retain subscribers. Over the long term, the company has seen strong, above-average growth in revenue and earnings.

However, the stock’s overbought condition and overvaluation make me cautious about next year. Experts predict a recession in 2023 as rising interest rates slow economic activity. If a recession does occur, even for growing companies, it could cause stocks to fall. Of course, Calix’s business could slump during a recession if BSPs cut spending.

I think most of the good news is priced in at this point. Personally, if I owned this stock, I would get some profit off the table by selling about half my position. If I want to start taking a position in the stock, I’ll wait for a more attractive entry point, which may come sometime in 2023.