2023-11-21 15:38:25 ET
Summary
- Fabrinet is benefiting from the AI boom by assisting companies like Nvidia in scaling their datacenter products related to AI.
- The company's fiscal Q1 2024 results showed strength in the datacenter sector but weakness in telecom and automotive.
- Fabrinet has a net cash position and is able to expand or repurchase shares, giving it an advantage over competitors with high debt levels.
Fabrinet ( FN ) is one of the big beneficiaries of the recent AI boom although it may be one of the quietest. The company is a contract manufacturer that flies under the radar by doing the work to help the largest companies like Nvidia ( NVDA ) scale. Recently Fabrinet has started assisting Nvidia in scaling datacenter products related to AI, providing a nice boost in growth and the share price. Consistently strong execution as well as lower volatility than peers makes FN a strong way to play the AI space, even after a recent large jump in the share price. I wrote about Fabrinet in May 2023 with a strong buy recommendation as interest in AI began to run up, which has been met with a 60% increase in FN since that article. The thesis has been proven correct, with potential upside albeit with a more balanced risk to reward now for FN shares. Being agnostic to the current trends in the market are a big benefit for Fabrinet, allowing it to benefit from all environments as its customers change focus or product lines.
Fiscal Q1 2024 results - As investors expected
FN results for the third quarter came in mostly as expected which is to say incredible strength from datacenter and weakness from telecom products. The company is also seeing some weakness starting in the automotive sector which has been a strong vertical for the semiconductor industry in recent years. The company has continued to take share in the optical communications sector, growing even as some of its competition has struggled with reduced order volume. Revenue was $685.5 million in Q1, up 5% over the prior year even with one less selling week in the quarter. Operating margins were off a bit, down 0.2% to 10.5% as the telecom weakness flows through to the bottom line with it dragging on gross margins. Still FN was able to increase earnings over 2023 Q1 with $65.1 million GAAP net income and $72.8 million Net Income when adjusting for share compensation. The company is also sitting on a net cash position, allowing it to expand for additional capacity or repurchase shares with free cash flow. It has $670.8 million in cash available at the moment, some of which is earmarked for its next manufacturing facility, but the rest is available to buy back stock. It's competition like Lumentum ( LITE ) and Coherent ( COHR ) both have significant debt levels, hurting overall share performance due to high interest rates in the current climate. When the telecom sector rebounds those two will provide bigger upside, but I contend FN will outperform over longer periods due to lack of debt load.
FN Revenue Contribution (Q3 Presentation)
As you can see from the chart above, FN telecom revenue is down more than 30% from its peak a year ago. However, datacom revenue has jumped 100% in just two quarters, all from 400 gigabyte per second and above products. Telecom revenue was helped by DCI or datacenter interconnect revenue as well, which is a growing area as the need for datacenters continues to grow. Year over year growth of 160% shows that the AI boom is very real, at least for a company the size of FN that can see outsize benefits from it. Automotive has seen growth level off after a significant ramp last year, but will still be a strong long term growth driver for Fabrinet. CEO Seamus Grady guided to a bottom in telecom by the middle of 2024, with hope for some growth there by the end of FN's fiscal 2024.
Operating margin improvement continues to support the stock multiple, with the stock trading at the high end of its forward earnings range. While growth is down to just 5%, operating margins continue to improve although they have been starting to level off. Artificial intelligence applications will be essential to further ramping revenue and margins in the coming few years. The key to the forward P/E expansion is expecting revenue growth of 7.6% for 2024 and 14.4% for 2025. These are high expectations predicated on an improvement in telecom revenues and continued growth in the AI datacenter piece. While the latter is likely to continue outperforming with Nvidia ramping, telecom sector recovery is hard to pinpoint with companies pulling back on spending in other areas. This may continue longer than the market expects, with potential for an even greater drawdown there if a recession forms. These areas are very cyclical and it has been quite some time since a more significant downturn, so caution is warranted with the older parts of the FN business. On the other side, FN continues to outperform competition by taking new contracts and expanding with its customers to do larger deployments.
Conclusion - Hold on valuation
While those who hold Fabrinet should continue to do so, I would be more hesitant to put fresh money to work on FN than in the past. FN has priced in strong growth now for 2024 and 2025 from AI applications, and some recovery in telecom is likely expected as well based on commentary. That means less upside possible since the rebound is quite priced in at these levels. Below $150 I would say FN is a buy, but at $165 dollars it would be a hold. Long term Fabrinet is one of the best equipment plays with stable revenues and earnings due to its contract manufacturing nature. They have great client relationships and are continuing to take market share. Investors would do well to add FN on pullbacks, and hold for long term share price appreciation.
For further details see:
Fabrinet: Datacenter AI Push Offsetting Telecom Weakness