JDS Uniphase: Upside Opportunity with Ramp Up in Demand
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JDS Uniphase Corporation (NASDAQ: JDSU) delivered solid FQ4 results against a challenging macro backdrop as the results exceeded the consensus from both a top and bottom line perspective. JDS management still expects carrier spending to modestly increase in 2H12 which could result in a solid margin improvement coupled with cost cutting, improved procurement and improved product mix. While there is an inherent risk that carriers could lower their existing CAPEX plans, we believe the reward outweighs the risk, particularly if optical demand continues to ramp with the expansion in 3G and 4G.
Service provider networks are running hotter and hotter with the increasing usage. Despite Traffic growth being inexorable, spending on connectivity has lagged in 1H12. We believe that the carriers would eventually have no choice but to spend and pick up CAPEX even in these weak macro conditions to ensure that their networks stay viable. Management seemed pretty confident about the increase in demand from carriers. JDS’s optical component peer Emcore (NASDAQ: EMKR) already announced it plans to double the capacity for its lasers sold into 40G/100g coherent systems pointing to the incoming strength in these markets. Neo Photonics (NYSE: NPTN) also reported strength in 40G/100g during its earnings due to increasing demand from Ciena (NASDAQ: CIEN), Alcatel and Cisco. With these developments, we remain positive that the stocks could see a run up with the CAPEX flush from the carriers in 2H12. Our belief that the demand will increase is strengthened looking at the lean inventories amongst the weak macro conditions. We believe that the demand of components could increase in the near term as the inventories remain weak with no room for further reductions. We have seen it in the past in the semiconductor industry which saw a rebound long before the economic conditions improvement in 2009 and we believe that we may see it in the components industry also.
Apart from the strengthening in demand in the Communications and Commercial Optical Products (CCOP) segment, we believe that JDS can see an increased traction for its products like PacketPortal, and PacketInsight. Management noted that PacketPortal has started gaining initial traction as it already has 3 customer orders and has completed 15 trials with an additional 6 trials in progress. JDSU also shipped 10 units of an initial PacketInsight order to a major Tier 1 North American service provider, and trials are in progress with 10 additional customers. We believe that the new products could yield growth for JDS even in the weak conditions. Furthermore, we view gesture recognition as a significant opportunity for the company. Although the business currently represents a minor part of the revenues, JDS recently signed an “advanced development contract” with a major home entertainment customer in the home entertainment arena which could help JDS to leverage this opportunity in the long term.
We believe that JDS shares have been under considerable pressure as investors have fretted over weakening conditions. A turn in this sentiment with the strong earnings has already been seen as the stock prices have soared higher. We still see a plenty of upside to the stock prices with the continued demand in 40G/100g and increased traction in new products and hence rate JDS as a buy.
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