This column was originally published on RealMoney on July 17 at 7:26 a.m. EDT. It's being republished as a bonus for TheStreet.com readers.
Shares of Creative Technology ( CREAF) have declined about 26% since I wrote about it last August and it's now trading at a seemingly dirt-cheap valuation of 0.3 times sales. However, the fact that I'm using an enterprise value to sales metric is a sign of the company's problems -- it can't generate profits despite red-hot end markets. I believe Creative is likely to experience more pain going into this holiday season. Creative's margins have been obliterated by its massive push into MP3 players, where it, along with many others, has been unable to make headway against Apple's ( AAPL) iPod. In the fiscal year ended June 2004, Creative's gross margins were a very strong 35.5%, but they dropped to 13.9% over the last 12 months. Note that the 13.9% figure includes inventory writedowns, which I chose to leave in because I believe the company may have to continue writing down inventories going forward. The company is aiming to return gross margins to 20%. Creative's balance sheet has also deteriorated. At the end of March, the company had had $102 million in net cash, down from $238 million at the same time last year and $390 million two years ago, when the company had very little long-term debt. That net cash balance has been fairly steady for the last three quarters, but the company's cash flow statement shows it hasn't been from any kind of operational strength. A great deal of the cash came from falling inventories: Since the company had so much inventory in the past, it didn't have to buy a lot of new stuff. Besides, inventory is still high at current levels. Plus, the company received a boost from the sale of some long-term investments, the balance of which includes a big slug of Sigmatel ( SGTL) stock, which is down over 65% year to date.