3rd Quarter Preview: Optical Components
Telecommunications Equipment
October 17, SUMMARY
2001 * Excluding AGRA and AVNX, all of the companies we follow
have pre-announced CY 3Q earnings. Given this, investors
Timothy are likely to look through most of the earnings reports and
Anderson focus on the outlook commentary.
* In the handful of equipment companies that have reported
Sept. earnings, including JNPR and TLAB, we have heard a
subtle change in tone toward the positive. However, the
transport equipment commentary is somewhat conflicting, and
it is too early to draw conclusions.
* We are concerned about the outlook for photonics and
remain on the sidelines with most names for two reasons.
First, we don't think <b.next year's carrier capital spending
cuts are fully accounted for by telecom equipment suppliers.
Second, significant pre-releases from marquis companies like
NT and ONIS are likely to have slowed the rate of excess
inventory absorption, increasing the risk of a push-out to
the bottom timing in photonics.
SUMMARY VALUATION AND RECOMMENDATION DATA
Earnings Per Share
Company (Ticker) Price FYE Rating Target LTGR Current Yr Next Yr
Agere (AGRA#) $5.00 Sep Curr 1S $8.00 NA ($0.44)E ($0.49)E
Prev 1S $8.00 NA ($0.44)E ($0.49)E
Avanex Corporation- $5.18 Jun Curr 3S $5.00 NA ($0.35)E NA
(AVNX) Prev 3S $5.00 NA ($0.35)E NA
Corning Inc. (GLW#) $9.01 Dec Curr 3H $10.00 10% $0.46E $0.00E
Prev 3H $10.00 10% $0.46E $0.00E
JDS Uniphase (JDSU) $9.04 Jun Curr 3S $6.00 20% ($0.03)E NA
Prev 3S $6.00 20% ($0.03)E NA
Newport Corporation- $17.32 Dec Curr 3S $19.00 NA $0.75E $0.48E
(NEWP) Prev 3S $19.00 NA $0.75E $0.48E
OPINION
The majority of the companies we follow have pre-announced their September
quarter earnings. As a result we think investors are likely to focus on the
outlook. Below is a summary of the issues we think companies are likely to
address during the earnings calls.
PHOTONICS INDUSTRY SUMMARY
We think the difficulties surrounding photonics companies are well known, and
the majority of valuations are not compelling. Marquis optical systems
vendors like Nortel and ONI Systems have pre-announced weaker than expected
sales. Carriers are in the process of aggressively lowering their 2002
capital spending budgets. For photonics, the fundamentals remain challenging,
and visibility poor. The impact of these issues has caused the shares for a
number of the photonic names to fall 95% from their 52 week highs.
Recognizing this, we also think the majority of the companies we follow,
excluding Agere Systems, have not yet reached compelling valuation levels.
Our position on the industry remains cautious over the intermediate term
largely predicated by anticipated sluggish spending by carriers in 2002 on
optical systems in both long-haul and metro applications.
Of the few telecom equipment vendors that have reported, we recognize a
subtle shift in tone, but it is still too early to draw definitive
conclusions. Interestingly, Tellabs, on its earnings call, suggested the hot
spots in carrier networks are starting to show. This implies carriers may
need to start to gradually increase their purchases of line cards. If true,
this would be a positive for component sales. In addition, JDS Uniphase
suggested it thinks the decline in photonic sales may be slowing. On the
other hand, Juniper suggests sales into the transport portion of the network
(optical) would likely remain weak into 2002. (Juniper's products do not sell
into this part of the network, explaining why the company raised its
guidance, despite the comment.) Although these comments do not appear to
offer consistent direction, we acknowledge this is the first quarter we have
heard some form of constructive commentary at the OEM level. It suggests the
frozen state of the photonics industry may be starting to crack. However, we
don't think next year's carrier spending levels are reflected in these
comments. As a result, we think it is too early to draw definitive
conclusions. Furthermore, driven by a weak economic backdrop, declines in
wholesale demand, and the events of Sept. 11th, Broadwing said the December
quarter would be its most challenging yet this year. As a result, we remain
cautious about the outlook for photonics.
PHOTONICS INDUSTRY EARNINGS PREVIEWS
AGERE SYSTEMS
We think the company is likely to report at least in-line earnings. As has
been the case with most communications component suppliers, Agere is
suffering from weak end market demand in both Comm IC and Optical component
divisions. Driven by low gross margins, overall profitability, and the delay
in distribution of stock currently held by Lucent, Agere currently trades at
0.7 price/book ratio. This is at the bottom end of the range for the
semiconductor industry.
Given this valuation backdrop, we find the name the
most attractive of the companies we cover at current levels.
We believe our modeling is conservative, and we think Agere is likely to
report earnings essentially in-line with consensus. During the company's
June quarter conference call, the company guided down 30-35% for September to
between $600-650 million. We have forecast the company sales slightly below
this guidance to $594 million. Based on this, our forecast for earnings is
for a loss of roughly $0.33 per share. This is conservative compared to the
First Call consensus average of a loss of $0.31. We expect Agere to report
earnings essentially in-line with this number.
Looking forward we continue to see fundamental recovery overhung by inventory
and weak end market conditions, but the situation is gradually improving.
Looking forward, we expect flat sales guidance for December as improving
inventory conditions are negated by falling end market demand. Specifically,
we expect photonic sales to decline modestly in the December quarter, and we
think semiconductor product sales are likely to start to show early signs of
recovering performance. We also expect management to guide to improving GPM
after September, which are expected to be roughly 0% in September. For
CY2001 (Agere has a September ending fiscal year ), we are modeling EPS
estimates of a loss of $0.74 per share, and for CY2002 we are forecasting a
loss of $0.27 per share assuming sales contract approximately 15% year over
year in the period.
AVANEX
Avanex likely to report earnings essentially in-line, but despite this and
relatively inexpensive valuation, end market concerns keep us cautious.
Avanex has not pre-released its quarterly outlook. Typically, management has
pre-released if its earnings have come in dramatically short of consensus
numbers. Based on this, we think the company is likely to report earnings
essentially in-line with the First Call consensus earnings average of a loss
of $0.08 per share. Such a report, we think would have a mild positive
impact on the company's shares. However, the name has jumped nearly 100% in
the past two weeks to $5 per share from a bottom of $2.35 per share. The
name is also trading at 50% over cash value of roughly $3.30 per share. With
few contract wins announced this quarter, and with optical component sales
likely to continue to slide into December, we remain cautious about the long
term prospects for the name.
Traction with Cisco is likely the highlight of the quarter, but, in our
opinion, the outlook for this name remains markedly risky. Avanex reports
earnings on October 22nd. We believe management is likely to keep guidance
tabled. For the positives, we expect management to focus on restructuring,
Fujitsu and Cisco. We think Avanex has made solid progress on its goal of
containing its costs and keeping its cash burn rate between $5-$10 million
per quarter. At the beginning of July the company announced it had entered
into an agreement with Fujitsu, a greater than 10% customer, to purchase
dispersion compensators based on the company's 'virtually imaged phased
array' concept. We note quantities and timing of sales were not specified,
but this contract suggests relations between the two companies remain solid.
Lastly, we expect management to focus on the company's relationship with
Cisco. Last quarter, Avanex announced it had gained a foothold with Cisco.
John Chambers, CEO of Cisco, indicated the company would exceed its earnings
forecast for the October quarter. We think Avanex may be a beneficiary, a
point we expect to hear Avanex management expound upon. Balancing these
positives are continued concerns about the outlook for optical components.
Nortel's September quarter revenue fell 25% below consensus. ONI Systems
pre-announced a 50% revenue short-fall. The ILECs are poised to lower
spending across the board in 2002, raising concern that the spending rates
for metro based optical equipment are likely to slow. With this kind of
backdrop, we think investors have time to continue to evaluate the name.
CORNING
With little data to work with from its pre-release, we think Corning is
likely to report earnings essentially in-line with consensus... Corning
reports earnings on Thursday the 18th, after the close. The conference call
is the following morning. The company pre-released the quarter indicating
its optical businesses continued to weaken through September, and that its
was taking the dramatic step of closing the majority of its optical fiber
manufacturing facilities and laying off an additional 4,000 employees. The
First Call consensus earning average stands at $0.04 per share. Excluding
one estimate of $0.12 per share the average is $0.03, and we think the
company is likely to report earnings around this level. Our earnings
forecast stands at $0.02 per share.
...But investors are likely to focus entirely on the outlook, not the current
quarter. As a result of the announcement, we don't think investors are
likely to focus on 3Q earnings. Rather, we expect the focus to center around
the outlook for fiber and photonics, and the amount of cost savings the
company expects to receive from its newly announced restructuring program.
Management to provide details on restructuring cost savings, and this
guidance could provide a mild short-term catalyst for the shares. The
company's earnings pre-release did not contain any cost savings detail,
management had not completed the benefit calculations. We expect more detail
in the earnings release. We estimate the company may save up to $300 million
in annualized benefits from the layoffs, and $80-$100 million from the
furlough of its fiber manufacturing employees for three months. In our
opinion, announced benefits beyond these levels may act as a mild catalyst
for the shares.
However, with no sales bottom in sight, we remain cautious about the name.
Concerning the outlook, we expect Corning to provide few positive data
points. Our field checks continue to suggest fiber inventories at carriers
are above normal levels, particularly for ILECs. Furthermore, the fiber
pricing environment remains soft, and carriers continue to lower their
aggregate 2002 spending levels. According to our Japanese sources, pricing
on flat panel display glass has not bottomed, and display inventories are
above desired levels. Based on the world outlook for truck and auto sales,
we also expect continued mild pressure on the company's thin walled ceramic
substrates business for the next several quarters. Although we find it hard
to imagine the outlook for the company getting worse, the majority of
Corning's businesses are under pressure, with little visibility on a bottom
in sight. As a result, we remain cautious on the name.
JDS UNIPHASE
Ahead of plan restructuring initiatives could provide a penny or so of upside
to consensus, on lighter than originally forecast revenues. JDS Uniphase
pre-released its earnings in late September, indicating revenue would come in
around $325 million, below the consensus levels of around $345-$350 million.
Management also indicated it was ahead of plan with its restructuring
efforts. As a result, we think the company is likely to report earnings a
penny or two better than the First Call consensus average, and our estimate,
of a loss of $0.03 per share. The company reports earnings on October 25th,
after the close.
Expectations suggest 2002 is likely to be a period of minimal sequential
sales growth. We expect investors to focus on the company's earnings
outlook. As a part of its lowered September quarter guidance, JDS Uniphase
management indicated it believes the company's sales are approaching levels
from which the company can grow. Furthermore, management is counting on
sales to step-up sharply as the inventory overhang in the channel clears. We
recognize inventory restocking is likely to drive a bump in sales for the
company. However, we also think this is likely a one-time event. Our
optical systems sales expectations suggest 2002 is likely to be a period of
modest to no sequential sales growth. Carriers, in both long haul and metro,
continue to materially cut their capital spending budgets for next year, and
key JDS Uniphase customers like Nortel, continue to miss revenue targets. As
a result, we think the photonic industry fundamentals over the intermediate
term are difficult to get excited about. Furthermore, we do not think sales
have bottomed. Our sources indicate channel inventories of optical
components remain high, and product obsolescence has not yet become acritical factor.
The name appears much more attractive compared to a year ago, but is not
inexpensive. JDSU's sales are down roughly 70% from peak levels. In
addition, sales are down 45% from the June quarter. It is hard to imagine
this performance repeating. We recognize often the right time to step into a
components name is when the sequential rate of sales decline slows, and we
think the September quarter may represent this point. However, this strategy
only works if the valuation is compelling. In our view JDS Uniphase remains
expensive. For example, even if we make aggressive sales and earnings
assumptions off our December quarter 2002 earnings forecast of $0.03 per
share, we don't see JDS Uniphase earnings more than $0.14 -$0.16 per share in
2003. Excluding interest income of $0.02 per share and roughly $1.30 in cash
per share on the balance sheet, this implies the company is trading at PE of
over 50x. As a result, we remain cautious on the name.
NEWPORT CORPORATION
We are expecting sales to come in in-line with pre-announced expectations.
Newport pre-announced its 3Q earnings in September. Although our field
checks indicate the company continues to experience order cancellations, we
think sales have been solid enough for the company to hit its pre-announced
revenue guidance of $58-$62 million for 3Q. Based on this we expect earnings
to come in essentially in-line with the first call consensus earnings average
of $0.01 per share. The company reports earnings after the close on October
17th.
We recently launched coverage on Newport with a Neutral rating. Long-term we
believe NEWP is a well positioned company, one that can leverage its solid
balance sheet to play a key role in photogenic automation and 300 mm
semiconductor wafer process equipment upgrades. However, we see few near-
term growth catalysts. In particular, component manufacturing lines are
idle. As a result, we expect weak near-term demand for NEWP's manufacturing
equipment. Furthermore, capital equipment names lag in a cyclical recovery.
As a result, we think the risk of potential earnings disappointments over the
next 1-2 quarters remains high. On the earnings call, we expect management
to talk positively about the near-term opportunity for the name. Even if
management reiterates it can achieve flat quarter to quarter revenue growth,
we think the key turning point for this name will be to find signs of
stabilization in component manufacturing utilization. Until then, we are not
likely to view these shares more constructively.
QUARTERLY ESTIMATES PER SHARE DATA
Current Year* Next Year Next Year + 1
Ticker Period Current Previous Current Previous Current Previous
AGRA# 1Q $0.06A $0.06A ($0.25)E ($0.25)E NA NA
2Q $0.00A $0.00A ($0.12)E ($0.12)E NA NA
3Q ($0.17)A ($0.17)A ($0.08)E ($0.08)E NA NA
4Q ($0.33)E ($0.33)E ($0.04)E ($0.04)E NA NA
Year ($0.44)E ($0.44)E ($0.49)E ($0.49)E NA NA
AVNX 1Q ($0.10)E ($0.10)E NA NA NA NA
2Q ($0.09)E ($0.09)E NA NA NA NA
3Q ($0.08)E ($0.08)E NA NA NA NA
4Q ($0.08)E ($0.08)E NA NA NA NA
Year ($0.35)E ($0.35)E NA NA NA NA
GLW# 1Q $0.29A $0.29A NA NA NA NA
2Q $0.28A $0.28A NA NA NA NA
3Q $0.02E $0.02E NA NA NA NA
4Q ($0.13)E ($0.13)E NA NA NA NA
Year $0.46E $0.46E $0.00E $0.00E NA NA
JDSU 1Q ($0.03)E ($0.03)E NA NA NA NA
2Q ($0.01)E ($0.01)E NA NA NA NA
3Q $0.00E $0.00E NA NA NA NA
4Q $0.01E $0.01E NA NA NA NA
Year ($0.03)E ($0.03)E NA NA NA NA
NEWP 1Q $0.40A $0.40A $0.07E $0.07E NA NA
2Q $0.32A $0.32A $0.10E $0.10E NA NA
3Q $0.00E $0.00E $0.13E $0.13E NA NA
4Q $0.03E $0.03E $0.18E $0.18E NA NA
Year $0.75E $0.75E $0.48E $0.48E NA NA |
