By David Sterman
T.S. Eliot once wrote that "April is the cruelest month." Yet a
half-dozen companies that sell optical networking equipment would
beg to differ: March has been quite cruel and they're hoping April
will be far kinder.
The entire group rallied higher in the first week on word that
Juniper Networks (
would be ordering more optical networking gear to be used in its
switches and routers. But my Monday, March 7, a raft of bad news
would overtake the sector. That morning,
predicted sales in the upcoming quarter would take a hit, because
customer orders had begun to slow and inventories of unsold optical
networking components were piling up. Ciena,
JDS Uniphase (
all fell at last 7% that day.
The bleeding wasn't finished. Finisar weighed-in the next day,
predicting sales in the quarter ended in April would lag forecasts,
thanks to slowing customer orders. Finisar added the concern for
much of the slowdown was coming from China, a market that was
expected to account for major growth in 2011.Those same stocks that
fell by high single-digits on March 7, all fell by double-digits
the next day. The next few days weren't much better, and all of
these stocks are off 30% to 60% since then.
Some industry watchers saw this coming. Demand for optical
networking gear, which helps data traffic to move very fast through
communications networks, soared 40% in 2010, according to industry
research firm Ovum. Much of that growth was the result of customers
stockpiling equipment to avoid being hit by any supply shortages.
With key customers now sitting on ample amounts of unused
equipment, a sales slowdown now seems to have been inevitable in
The quarterly slowdown increasingly looks to be the result of an
industry with limited visibility, but the major customers for
optical networking equipment are nowhere near the end of the line
in terms of growth. In China, for example, where optical networking
helps boost data transmission speeds, only 100 million handsets
will be 3-G-capable this year. That's twice the amount of 2010 but
still a faction of the 850 million handsets in use in China.
In the United States, the installation of optical networking
equipment will remain crucial if carriers are to keep up with the
exploding amount of data being consumed on wireless networks.
That's not to say the industry will see an immediate bounce back.
Analysts at Stifel Nicolaus figure the inventory overhang may stick
around through the summer. The key for investors is to see
inventories coming down and not wait until they have truly been
worked though. When that finally happens, demand is likely to
rebound for many of these firms and analysts will start to speak of
that turn before it happens, implying share price rebounds ahead of
a pick-up in demand.
Analysts at ACI Research think near-term inventory concerns are
obscuring a larger brighter picture. They attended the annual
Optical Fiber Conference ((OFC)), held earlier this month in Los
Angeles, and noted that part of the slowdown is the result of key
customers looking to step back and be sure they're keeping up with
all of the industry's advances: "With advances come
discontinuities. This heralds a tremendous amount of volatility for
public companies. But make no mistake. It was the most exciting OFC
in recent memory." (They're referring to the wide range of new
products released at the show.)
(Click to enlarge)
Names to own
Analysts at Auriga Securities think
will be the first to rebound, thanks to a range of newly-released
products reaching customers in the spring. "The June 2011 quarter
is pivotal for the company as new products including ROADM
(reconfigurable optical add-drop multiplexer) and 40G
transceivers." They seeshares rising from a current $11 to $14.
Longer-term, shares could rebound back to the 52-week high of
$19 because Oclaro has considerable exposure to the Chinese market:
China's Huawei, the world's second-largest telecom equipment
provider, accounts for 17% of Oclaro's sales, a figure that has
been steadily rising in recent years. Another play is San Jose,
, which derives 50% of sales from China. Shares of this early
February 2011IPO have already fallen by half from their peak.
Citigroup's analysts attended the same OFC conference and came
away with their bullish industry view intact, despite the recent
problems. They were particularly impressed with
, predicting the company "will be a share gainer through the next
cycle and expect to see a significant deal win over the next 90
days." They see shares rising from $24 to $34 in the next 12
If you're aGARP (growth at a reasonable price) investor, you
have to find high-growth industries that have become reasonably
priced due to near-term growing pains. The optical networking
stocks have plenty of room ahead of them, yet are currently being
scorned while demand temporarily slows. As demand rebounds, so will
Neither David Sterman nor StreetAuthority, LLC hold positions in
any securities mentioned in this article.
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