Which Optical Stock Will Reward You?

Declan is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

This week I have gone for a former IPO darling that ultimately fell flat on its face, but now looks fit-and-ready to challenge once more.   Fabrinet (NYSE: FN) debuted in 2010 at a discount to its initial IPO price, but soon found its feet to rapidly ascend to $32.91.  However, the joy wasn't to last, and it subsequently entered a steady decline, ultimately visiting its IPO lows in October of last year.  However, the stock has since found a new lease on life, enjoying a series of heavy accumulation days to bring it back to where it lies today.

The major reversal in its fortune came in November, not long after its all-time low, when it delivered on better than expected earnings.  Revenues had been steadily increasing since the end of 2011, which ran contrary to its price action, but November finally saw positive price action to match solid earnings.  Then its reported revenue of $158.6 million was ahead of the expected $147 million, even though it was down nearly 15% from a year earlier.  However, when factored for Price per Sales (0.8) and Price per Book (1.5), the stock became far more attractive to buyers. 

Fabrinet's earnings in February continued November's good form.  Revenue grew to $167.5 million on a 73% growth in reported sales.  A gross margin of 11% and operating margin of 7.5% also came in ahead of November, and finished goods inventory dropped from the previous quarter.  February's earnings simply reaffirmed valuations and enabled buyers to take out the $14 ceiling that had previously attracted sellers.  Even at current prices, Price per Sales still remains below 1.0, with a Price per Book at just under 2.0.

Going forward, there was no change in raw material inventory, which suggests flat growth for the next quarter.  But does that mean the best is past it? Is there anything we can learn from companies in its industry?

Oplink Communication (NASDAQ: OPLK) is considered a direct competitor to Fabrinet, although it's able to run significantly higher Gross Margins at 38.6%.  It recently reported earnings, which were at the top end of expectation with a weak quarter in Asia - although there was pick up in Asian markets for December.  Its expectations were flat for American, European, and Asian markets, which reaffirms Fabrinet's outlook.  

JDS Uniphase Corporation (NASDAQ: JDSU) has a long standing relationship with Fabrinet, as investment, customer, and supplier.  JDS Uniphase Corporation's Optical Communications and Lasers business reported a 4.9% sequential drop in revenue in fiscal Q2.  Despite the loss in revenue, gross margin grew to 28.3% from 27.5%.  Laser sales also fell 5.3% from Q1, but gross margin edged out a small gain to 44.4%.  Next quarter, JDS Uniphase Corporations expects a slight increase in demand for optical components, but this will be offset by a further decline in demand for lasers; the net outlook is for a flat to +3% gain in revenue, with operating margins around 8% to 10%. 

Alan S. Lowe, President of JDS Uniphase's CCOM division, noted a pickup in Optical orders for January compared to October, which should lead to an increase in the June quarter as a result of "pent-up demand."  Asia was becoming a larger component of JDS Uniphase's revenue pie, as it grew from 23% of revenues and is expected to reach 26%.  It's possible both Oplink and Fabrinet are overly cautious in their outlook, with demand for Asia offering the possibility for surprise.

Finisar Corp (NASDAQ: FNSR) operates in the development and manufacture of optical subsystems.   The company last reported a 5.2% revenue growth compared to JDS Uniphase's 1.2%.  More importantly, it was gaining market share, and its outlook was buoyant.  Its proprietary optical engine product "has been a great success," with a key routing opportunity arising from it.  The company sees optic content in data centers as a key growth opportunity (through 2015), and this may be of benefit to Fabrinet.

As an aside, Finisar's stock price is attempting to break past $17, a level which has proven to be attractive to sellers in the past.  It's looking to repeat what Fabrinet was able to do when it pushed past $14.  However, where it struggles is its Price to Sales ratio of 1.6, which is above what may be considered 'cheap' for a stock (below 1.0).  This is still one to watch though.

Outlook

Based on the broader optical market, Fabrinet should be able to come in at the top end of its own modest expectations, as it has done in the past.  The stock was brow beaten to a point where it offered excellent value, and recent earnings reaffirmed such evaluations.  Assuming net income for the next two quarters was comparable to last quarter, it would have a ttm P/E of around 10.0 (at current prices).  This compares very favorably to an industry average of 15.3, and well below a direct competitor, Oplink Communications' current P/E of 66.3. 


fallond has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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