Severe Static For Telco Suppliers

By Stephen D. Simpson, CFA | March 11, 2011 AAA

When a sector sits in the top 5% of sector performance, it is often a safe bet that momentum investors have crowded into the stocks, and expectations are running hot. Unfortunately, the very nature of the momentum game means that the stocks can get rocked at the first sight of cracks in the growth story.

Such is the case for companies in the telecomm equipment space these days.

IN PICTURES: 5 Steps Of A Bubble

Investors had been piling into stocks like JDS Uniphase (Nasdaq:JDSU), Finisar (Nasdaq:FNSR) and Ciena (Nasdaq:CIEN) on the idea that the spread of smartphones and tablets is going to strain the networks of service providers even further and lead to significant capacity upgrades. To be fair, growth had been looking good off the bottoms of the recession and demand in China has been strong.

Unfortunately for investors, it looks like the sector has hit a pothole. Although JDSU gave pretty encouraging guidance not all that long ago, Finisar had a much less rosy outlook. Not only did Finisar cite weaker growth in China as a proximate cause, the company indicated it was an industry-wide phenomenon. Couple that with disappointing guidance from Ciena, and the stage was set for a significant pullback.

Where To from Here
As the following table suggests, investors are not exactly looking at bargain valuations in the sector even after some corrections. Investors should also note that the impressive-looking revenue growth estimates likely will be coming down as analysts refine and readjust their models in the wake of these announcements and guidance.

Ticker EV / Rev EV / EBITDA Two-Year Est Rev Growth (CAGR) 12-Month Stock Perf.
JDS Uniphase (Nasdaq:JDSU) 3.4 30.9 22% 84%
Opnext (Nasdaq:OPXT) 0.9 n/m 16% 32%
Oclaro (Nasdaq:OCLR) 1.7 22.3 19% 18%
Oplink (Nasdaq:OPLK) 2.0 10.9 27% 34%
Finisar (Nasdaq:FNSR) 3.8 25.5 36% 80%
Corning (NYSE:GLW) 4.8 13.8 13% 20%
Ciena (Nasdaq:CIEN) 2.6 nm 30% 57%
Infinera (Nasdaq:INFN) 1.3 nm 6% -3%
Alcatel-Lucent (NYSE:ALU) 0.5 20.6 7% 55%

At least relative to JDSU, Opnext (Nasdaq:OPXT), Oclaro (Nasdaq:OCLR) and Oplink (Nasdaq:OPLK) look like they could be bargains. The problem, though, is that institutional investors are likely to run with the idea that if customers like Ciena, Huawei, ZTE and Alcatel-Lucent (NYSE:ALU) are pulling back, these smaller companies are going to be even more vulnerable to a slowdown. It may not be wise, fair or accurate, but in a twitchy market that has already enjoyed a good run, "shoot first, ask questions later" seems like the popular approach.

The Bottom Line
Investors have a few options today. The stocks of companies like Oplink, Oclaro and JDS Uniphase have already taken a pounding, and investors may just want to sit tight, wait it out and bank on the thesis that smartphone and tablet penetration is still quite low, and ongoing expansion will indeed require large-scale equipment upgrades from Verizon, AT&T and the like. Alternatively, investors could look at a more diversified and mature name like Corning (NYSE:GLW) - a name that does not have the same sort of volatility based on optical component market demand - as a compromise that gives them some of the same market exposure for less risk.

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