2023-10-19 03:54:07 ET
Summary
- Coherent showcased strong financial performance in the recent quarter, with notable revenue and commendable non-GAAP EPS.
- COHR holds a promising outlook in its datacom segment, particularly in AI-related applications, and has made significant investments in its Silicon Carbide business.
- Strategic partnerships and a strong business model position COHR well to tap into emerging markets and overcome short-term economic challenges.
Investment action
Based on my current outlook and analysis of Coherent ( COHR ) stock, I recommend a buy rating. Amidst macroeconomic adversities, COHR showcased a strong financial performance in the recent quarter. The company achieved notable revenue and a commendable non-GAAP EPS, reflecting its resilience and effective execution. As it navigates forward, COHR holds a promising outlook in its datacom segment, with a particular emphasis on AI-related applications. The surge in demand for high-data-rate transceivers, alongside a significant external investment in its Silicon Carbide business, places COHR on a positive trajectory. These developments, coupled with strategic partnerships, position COHR well to tap into emerging markets, promising a favorable outlook despite short-term, temporary economic challenges.
Basic Information
COHR operates in the technology sector, primarily focusing on developing and manufacturing innovative laser, photonics, and optics solutions. Their products find extensive applications across a diverse range of industries, including the industrial, scientific, medical, and microelectronics sectors. By offering a broad spectrum of laser technologies, COHR plays a pivotal role in driving advancements in various fields, making significant contributions to both commercial and technical spheres. Over the years, they have expanded their portfolio to include a variety of products and solutions, addressing the evolving needs of their clientele while tapping into new market opportunities. This has enabled COHR to establish a strong foothold in the market and foster a conducive environment for growth and innovation in the laser and photonics technology landscape.
Over the last 5 years, COHR’s revenue has been strong, growing at a CAGR of ~30%. However, from 2020 to 2020, it was on a declining trend, except for 2023, where it grew by 56%. COHR’s impressive 2023 revenue growth was attributed to several pivotal factors. Firstly, the company's resilient business model played a crucial role, underscoring its ability to withstand and thrive amid market fluctuations. This adaptability in their business framework was further augmented by the strategic acquisition of Finisar. This acquisition not only brought in significant shareholder value but also showcased COHR's prowess in integrating and maximizing the potential of its acquisitions. Furthermore, an emerging trend that positively influenced their financial performance was the surge in market demand for artificial intelligence. COHR adeptly capitalized on this rising demand, demonstrating their readiness to meet the evolving needs of the tech industry and affirming their position as a front-runner in the segment. Together, these elements—a robust business model, a successful acquisition, and a keen eye on tech trends like AI—solidified COHR's strong revenue growth for the year.
Review
In the fourth quarter 2023, COHR reported a revenue of $ 1.21 billion, exceeding the higher end of its guidance, and a non-GAAP EPS of $0.41, which was towards the high end of its guidance. The company also mentioned an operating cash flow of $182 million, marking both sequential and year-over-year improvement. They invested $93 million in capital equipment and retired $121 million of debt during this quarter. Despite the challenging macroeconomic environment, the company was able to execute well, which was highlighted by the executives during the earnings call. However, macroeconomic uncertainties , a slow recovery in China, and post-COVID market deceleration led to conservative order patterns in the fourth quarter. Some customers reduced legacy product orders and planned investments due to lower demand.
In COHR's recent communications market overview presentation , they outlined projections for its datacom transceiver segment, anticipating a growth rate of approximately 18% CAGR from 2023 to 2028. Within this segment, COHR predicts a remarkable CAGR of around 47% for AI-related applications (including 400G/800G and extending to 1.6T/3.2T beyond 2025), while foreseeing a CAGR of about 10% for non-AI applications during the same period. However, moving into 2024, it's noted from the management that there might be a pause or digestion period for non-AI datacom transceivers before they resume significant growth in 2025. In terms of market share, although COHR had a slight lead with around 22% in 2023 over InnoLight, which had about 21%, the management pointed out that with the transition to higher-speed technologies, the industry might see a reduction in competition. This scenario is expected to pave the way for notable market share increments for COHR, beginning with the deployment of 800G technologies.
Across COHR’s segments, materials and lasers are still underperforming, while the networking area saw a boost, mainly due to high-data-rate transceivers. The increase was primarily driven by the 800G transceivers, especially in the area of artificial intelligence and machine learning technologies. This surge in demand is likely to compensate for the foreseen reduction from conventional data centers and hyperscale customers. Additionally, there's potential growth projected from advancements in silicon carbide [SiC], notably in domains like electric vehicles. Nonetheless, in the near future, supply will struggle to meet demand, and the ability to augment revenue will be limited by the pace of production escalation. However, the recent investment from two major companies brings hope to meet the rising demand and the intensive capital requirements needed to ramp up production.
COHR’s SiC business recently garnered significant investment from Denso Corporation and Mitsubishi Electric Corporation, who collectively invested $1 billion. This investment stems from a strategic review process initiated in May 2023 to bolster this business segment. Each company invested $500 million for a 12.5% non-controlling interest in the SiC business, with COHR entering into long-term supply agreements with these corporations to cater to their 150 mm and 200 mm substrate and epitaxial wafer demands.
This business segment, known as Silicon Carbide LLC, was established by COHR in April 2023 and has since been separated into an independent subsidiary. The primary focus of this subsidiary is the manufacturing of SiC wafers?. These wafers are utilized in electric vehicles and other industries, showcasing the strategic importance of this business segment in tapping into growing markets and aligning with modern technological advancements??.
The substantial investment in its SiC business, along with long-term supply agreements with DENSO and Mitsubishi Electric, positions COHR as a key supplier in a growing market. This enhanced market position could lead to increased sales and revenue as the demand for SiC components, particularly in electric vehicles and power electronics, continues to rise. Moreover, strategic partnerships with reputable corporations like DENSO and Mitsubishi Electric not only provide an immediate financial infusion but also pave the way for further collaboration and innovation. These strategic alliances could foster new business opportunities, broaden customer bases, and potentially generate higher revenue streams from diversified product offerings and entry into new markets.
Valuation
I project that COHR will experience a negative growth of 9% in FY24, followed by a 7% growth in FY25. The projection for FY24 aligns with the management's revenue guidance of approximately $4.5 to $4.7 billion. This lower guidance is attributed to a challenging macroeconomic environment affecting some industrial and instrumentation sectors. Additionally, a slower-than-anticipated recovery in China and a post-COVID slowdown in the communications markets led to conservative order patterns in the fourth quarter of fiscal 2023. Management has dubbed FY24 a retooling year, indicating a phase of realignment to adapt to market realities. For FY25, my growth assumption aligns with the market consensus. This projection is rooted in management's view that the demand slowdown is temporary, although it impacts the revenue outlook for FY24. Secondly, as the adoption of artificial intelligence and machine learning accelerates, COHR's networking segment stands to benefit. Lastly, COHR's SiC business, although in its nascent stage, is anticipated to positively impact the revenue outlook as it continues to grow, especially given its recent recognition by two major brands.
COHR is presently trading at approximately 8x forward EV/EBITDA, while its peers are trading at a median of 12.3x. The fact that COHR’s gross margin of 31% is below the peer median of 47%, coupled with a lower expected growth rate of negative 8% for the next twelve months compared to the peer median of negative 4%, justifies COHR's lower forward EV/EBITDA trading multiple. My price target for COHR is roughly $41, indicating an upside potential of 22%. I am issuing a buy recommendation as COHR’s current trading price is at a discount to my target price, a discount driven by market apprehension due to the company’s guidance for a declining revenue outlook in FY24. However, upon closer examination, COHR’s fundamental business aspects appear strong, and the lowered guidance can be attributed to temporary challenges as outlined by management. Furthermore, COHR’s robust initiatives in the SiC domain and the growing artificial intelligence and machine learning market present a promising outlook for the company, although I anticipate these positive impacts to materialize from FY25 onwards.
Risk and final thoughts
A potential downside to my thesis is posed by inflation. Currently, persistent inflation has led the Federal Reserve to maintain strict monetary policies. There's a significant correlation between tech spending and inflation, as numerous companies are reducing their tech expenditures due to unfavorable macroeconomic conditions, given the absence of robust, strong growth in spending for them to leverage. Since COHR is heavily dependent on the tech sector for future revenue growth, particularly from growing markets like artificial intelligence, machine learning, and their SiC business segment, sustained inflation could continue to suppress tech spending, thereby adversely impacting COHR's revenue.
In the recent quarter, COHR exhibited strong performance despite economic challenges. The company demonstrated resilience in the face of adversity, reflected in its robust operating cash flow. Looking ahead, I anticipate promising growth in the datacom transceiver segment, particularly in AI-related applications, although a brief pause is foreseen for non-AI datacom transceivers as the company transitions into the next year. The networking segment received a significant boost, primarily from high-data-rate transceivers associated with AI and ML technologies, which is expected to offset potential declines from traditional clientele. Moreover, the recent substantial investment in COHR's SiC business by two major corporations underscores a significant stride towards tapping into burgeoning markets like electric vehicles. This investment not only elevates COHR's market position but also outlines potential revenue growth through strategic partnerships and diversified product offerings. These developments set a positive trajectory for COHR as it navigates through temporary economic hurdles towards a promising technological forefront, underscoring a favorable outlook for the company. On the basis of these factors, I recommend a buy rating for COHR.
For further details see:
Coherent: Temporary Economic Challenges With A Long-Term Growth Outlook