Telecommunications Equipment
Optical Component--A Likely Bright Spot In A Tough Tech Quarter
October 10, 2000 SUMMARY
* The dust is starting to settle on a bloody
pre-release season, with the LU pre-release likely
to hit all names associated with the segment hard
* As the heart of the new network technology names
step up to bat, we are anticipating results to be
bolstered by strong quarters from the marquis data
networking, optical systems and optical components
names
* The capacity constraints in the photonic and fiber
markets provide excellent visibility for the
quarter. Moreover, based on our conversations with
systems vendors and service providers throughout the
quarter the pace of network build and optical
hardware deployment remained remarkably strong,
suggestive of a robust 3Q outlook.
SUMMARY VALUATION AND RECOMMENDATION DATA
Earnings Per Share
Company (Ticker) Price FYE Rating Target LTGR Current Yr Next Yr
Corning Inc. (GLW#) $93.00 Dec Curr 1H $163.00 33% $1.08E $1.35E
Prev 1H $163.00 33% $1.08E $1.35E
JDS Uniphase (JDSU) $93.56 Jun Curr 1S $155.00 33% $0.69E $0.92E
Prev 1S $155.00 33% $0.69E $0.92E
SDL, Inc. (SDLI) $309.44 Dec Curr 2S $410.00 33% $1.38E $2.04E
Prev 2S $410.00 33% $1.38E $2.04E
WITH THE PRE-RELEASE SEASON OVER ITS TIME TO STEP UP TO TAKE ANOTHER HARD
LOOK AT JDSU, SDL AND CORNING
Following our series of notes on the data networking and optical systems
names, we think it's time to take positions in the blue-chip optical
components names. The pre release season is winding down, or perhaps even
over. The good news from the companies facing continued strong demand and
solid fundamentals should start to roll in. With the optical components
market and the optical fiber market both running at capacity constraints, we
expect strong reports out of JDSU, GLW and SDL. Our sentiment is underscored
by the announced quarterly performance of Lucent semiconductor and optical
components business. According to the Lucent call, this unit experienced
roughly 50% year over year revenue growth. Although sales are split roughly
one quarter optics and three quarters semiconductors, semiconductor sales
growth is less than 50% , suggesting optical component demand in 3Q was
indeed robust.
Seasonally, the beginning of October is generally a good time to position
into these stocks. The seasonal flow of capital generally starts to improve
at the end of the year in anticipation of the new year rally and as consumers
tweak their portfolios resulting in seasonally strong first quarter capital
inflows. We believe the concerns around the levels of service provider
capital spending have generally run the course. Furthermore, operationally,
we think the demand for optical components should remain strong going into
the new year with a couple more quarters of strong results likely ahead.
Our Favorite Names Are GLW and JDSUWe Also Expect Strong Results Out Of SDL,
But Are Mindful Of The Current Premium Build Into The Shares
JDS UniphaseStrongest Optical Component Pure-Play Should Easily Beat The Bar.
JDS Uniphase is expected to release earnings on October 26. Despite the
current concern in the market over next year's capital expenditures, optical
systems and optical components continue to see strong demand growth. Nortel,
for example, raised its optical systems sales guidance from $10 billion to
$12 billion in 3Q, and we think this number is conservative. As one of the
largest suppliers of optical componentry to Nortel, this implies JDSU is in a
robust position. Moreover, JDS continues to successfully move down the path
toward its goal of increasing capacity by 4x in any given 18 month period.
With all components manufacturers' facilities running at full tilt, JDS's
steady production expansion program provides strong visibility into the
company's revenue and earnings stream. Our fiscal first quarter revenue
forecast calls for growth of 19% quarter to quarter to $760 million from the
June-quarter's reported revenue of $641 million. This is in-line with
management's guidance, but we think there is room for solid upside. For the
last three quarters, JDSU has turned in over 22% quarter to quarter growth,
with the past two quarters' sequential growth rates over 32%. On an earnings
per share basis, we are forecasting $0.16 for the quarter. This is in-line
with the First Call consensus average. We are anticipating a penny or two of
upside to this level, based on stronger-than-forecast revenue growth. Our 3Q
operating margin forecast is set at 30.7% of sales. This is a 50 basis point
contraction from last quarter giving management maneuvering room as it
continues to move down the path of integrating the 10 acquisitions the
company has completed since August of 1999.
Looking forward, the pace of optical systems deployment looks solid for at
least the next several quarters. Based on the breadth of JDS's product line
we expect the company to continue to consolidate its market leadership in a
number of key areas. We look for the continued capacity additions to drive
revenues higher. Furthermore, we view the potential addition of SDL to JDS's
company portfolio positively as SDL's higher margins and strong pump laser
business should help to push JDS to new heights. We are reaffirming our
price target of $155 and our 1S, buy rating.
CorningPoised For Another Strong Quarter. Corning is expected to release 3Q
earnings on October 24th. Based on the continued build of optical networks
worldwide, we expect strong results from GLW. Telecommunications sales make
up 70% of Corning's revenue and drive the company's valuation. For fiber,
Corning recently raised its guidance on annual fiber volume growth to 40%
from 35% for 2000. With roughly 45% first half fiber volume growth, this
suggests growth in the second half should be equally strong, and on the order
of 35%. Furthermore, although more anecdotal, based on the Lucent prerelease
call from last night, management suggested fiber demand was strong through
the quarter, boding well for the market share leader, Corning. We think
Corning is tracking for at least $3 billion in fiber and cable sales in 2000.
Based on the strength of optical systems sales at Nortel, we think Corning's
photonics sales should come in strongly in 3Q. Corning is the key supplier
of optical amplifier sales to Nortel, and with Nortel's experiencing strong
systems demand, we think Corning's photonics business is likely to stand-out.
The other key areas of growth in the quarter are likely to come from the
company's strong position in precision flat panel glass fabrication. Corning
is the market share leader in flat panel glass production and is likely to
experience growth in excess of 40% annually. Our 3Q revenue forecast calls
for 52% year over year top line growth to $1.9 billion from $1.2 billion. We
think there is room for some modest upside, to this number driven by optical
components and fiber growth. On the earnings front, we are forecasting $0.29
per share versus $0.19 a year ago. This compares to the 3Q consensus average
of $0.30 per share.
One of the highlights of the quarter was Corning's announcement last week of
its intention to acquire 90% of Pirelli's optical components business. We
view the move favorably as it will strengthen the transmission portion of
Corning's photonic portfolio. Additionally, we expect that Pirelli's 980nm
pump business, which is being qualified for the submarine market, will
complement Corning's growing terrestrial pump business. Looking forward,
Corning's entry into the transport business combined with continued expansion
into the source laser business will distinguish Corning in the quickly
consolidating optical component market.
SDLNumbers Should Top Estimates Again. SDL expects to release earnings after
close on October 19. We are anticipating exceptional results from SDL. The
pace of network build-out has continued strongly in 3Q as service providers
like Level 3, Williams, and Broadwing continue to add to their networks.
With 60%-65% market share in pump laser modules, and the bulk of revenues
generated from this product segment, the continuing build of long haul
optical networks should position SDL nicely in the quarter. Moreover, the
continuing strong service provider demand for high-speed multi-channel OC-192
and OC-48 interfaces should enable the company's ramping Lithium Niobate
modulator business and transceiver driver electronic business to continue to
show solid gains. Furthermore, we expect continuing solid performance from
the submarine pump market, as SDL is quickly ramping its submarine pump
products and is becoming a strong presence in this high margin business. Our
revenue forecast calls for 27% quarter to quarter growth to $140 million from
$111 million. Although this is in-line with management's guidance, in the
second quarter, SDL turned in 53% quarter to quarter growth, including
acquisitions, and roughly 31% quarter to quarter growth excluding
acquisitions driven by stellar market conditions. With little apparent slow
down in 3Q, we believe SDL is in an excellent position to tack on several
points of growth to our top line forecast. On the earnings side of the
equation, we expect SDL to exceed our earnings estimate of $0.37 per share by
at several cents largely driven by revenue upside. First Call consensus
earnings are $0.38 per share. Our operating margin forecast is for 34.6%,
roughly 20 basis points higher than last quarter's reported margin of 34.4%.
SDL has a number of moving parts to its margins equation. The second quarter
results only contained a couple of weeks of results from Queensgate, PIRI and
Veritec acquisitions. Veritec has a margins lower than the corporate
average, but this is offset by PIRI, whose margins are higher than the
average. With integration of these units preceding smoothly and Lithium
Niobate modulator volumes likely ramping, boosting margins on a quarter-to-
quarter basis, and with acquisition integration proceeding smoothly, we are
only expecting modest margin improvements in 3Q.
QUARTERLY ESTIMATES PER SHARE DATA
Current Year* Next Year Next Year + 1
Ticker Period Current Previous Current Previous Current Previous
GLW# 1Q $0.23A $0.23A $0.27E $0.27E NA NA
2Q $0.31A $0.31A $0.36E $0.36E NA NA
3Q $0.29E $0.29E $0.36E $0.36E NA NA
4Q $0.25E $0.25E $0.35E $0.35E NA NA
Year $1.08E $1.08E $1.35E $1.35E $1.68E $1.68E
JDSU 1Q $0.16E $0.16E NA NA NA NA
2Q $0.17E $0.17E NA NA NA NA
3Q $0.18E $0.18E NA NA NA NA
4Q $0.19E $0.19E NA NA NA NA
Year $0.69E $0.69E $0.92E $0.92E NA NA
SDLI 1Q $0.22E $0.22E $0.45E $0.45E NA NA
2Q $0.33E $0.33E $0.49E $0.49E NA NA
3Q $0.37E $0.37E $0.53E $0.53E NA NA
4Q $0.43E $0.43E $0.56E $0.56E NA NA
Year $1.38E $1.38E $2.04E $2.04E $2.81E $2.81E |
