Ciena: Reiterate Buy Rating, Worst Of This Cycle May Be Over

seekingalpha06-19

CIEN's 2Q24 earnings exceeded expectations, with revenue of $911 million and gross margins of 43.5%.Management guidance for 3Q23 was not positive, but FY24 revenue guide remains strong, indicating a ...

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I reiterate my buy rating for CIEN, as I believe the worst of the cycle is over and FY24 should see inventory normalized. CIEN is also well positioned to capture share given its first-mover advantage in launching products to the market. Investment thesis On 06/06/2024, CIEN released its 2Q24 earnings, which saw revenue of $911 million vs. consensus of $895 million. The higher-than-expected revenue was driven by better performance in telecom and government. Gross margins saw 43.5%, which was modestly better than consensus at 42.7%. However, because of the fixed cost nature of the business, opex as a percentage of revenue grew to 36.7% vs. 29.8% in 2Q23 and 32.5% in 1Q24; hence, operating margin declined to 6.9%.   Own calculation Looking ahead, management guidance for 3Q23 was not positive. Management is guiding revenue of $880–$960 million, implying flattish sequential growth at the midpoint. However, the FY24 revenue guide was only moderated down slightly to $4 to $4.3 billion, which implies that 4Q24 will see a huge acceleration to meet the guide. Per my math, this FY24 guide implies 4Q24 revenue of ~$1.13 billion to meet the low end of management guidance, which implies a sequential growth of 23.4%. This would be the largest sequential growth CIEN has ever seen over the past few years. However, I believe CIEN will be able to deliver. There are several underlying demand drivers that make me positive about this. Number one, while I acknowledge that things could have been better, as CIEN noted in the 2Q24 results that customers continue to absorb inventory slower than expected, I believe the worst is over. There are already signs that telco inventory levels are steadily declining, coming back to more healthy levels. The first evidence is that CIEN’s service provider revenue and orders were up sequentially in the quarter. The second piece of evidence is that comments from industry players paint a similar picture.  Inventories are coming down to more healthy levels and demand is picking up in certain areas such as high-bandwidth memory. Additional new fab installations were announced this quarter. Keysight Technologies 2Q24 Customer inventory of our products is decreasing, indicating that we are getting closer to the end of this lower demand phase in our industry. 3Q24 Lumentum Holdings  As such, I believe we are nearing an end to these headwinds and expect strong sequential recovery growth ahead. Hence, I see a good possibility that CIEN can achieve the expected growth in 4Q24. Number two, I believe CIEN is well positioned to capture share in the industry, enabling it to recover faster. My core belief is that CIEN has a superior methodology to bring products to the market earlier than peers, giving them a period of no competition. This can be seen from the launch of their WaveLogic 5 Extreme, wherein CIEN was the exclusive solution on the market for 18 months (per 2Q24 earnings call). The adoption traction was also very favorable, suggesting that the CIEN product meets the customer's needs and works. This entire dynamic is happening again for the upcoming WaveLogic 6 Nano, which is also the first-of-its-kind in the industry, and I expect this to drive strong adoption as underlying customers aim to outcompete each other by having the best technology. The goal of outcompeting peers brings me to my third point. I believe telecom players have no choice but to step up their investments because of the rising demand for AI and machine learning. If they do not have the best optical networks, they risk losing customers. Hence, I believe CIEN is in the sweet spot to benefit from rising capital investment trends among its customers.   Own calculation If the sequential growth acceleration does happen as I believe it would, CIEN is very likely to also print strong margin expansion given the fixed cost nature. The volatile incremental margin profile proves my point. At the current 6.9% EBIT margin, I believe there is plenty of room for margin expansion as the business scales and the supply chain environment normalizes. Valuation   Own calculation My target price for CIEN based on my model is $63. My model assumptions are that revenue will recover to 10% growth in FY26, with the expectation that FY24 will meet management guidance (4Q24 to see steep growth sequential acceleration that implies ~flattish y/y growth). The reason for using 10% is because that was the growth rate that CIEN experienced for the majority of the 2010s (pre-covid). Growth could go past my expectations if the demand for AI drives telecom companies to significantly step up their investments. As revenue recovers, net margins should recover accordingly, given the incremental margins. I modeled margins to back to low teens at the minimal, which could be conservative as FY21 reported 13% margin with $3.6 billion of revenue. As the visibility to recover is getting clearer and the timing is near, I believe the market will continue to attach a premium multiple (relative to the CIEN historical average). At the current 18x forward PE, I believe CIEN has an attractive upside. Risk Ciena has been ahead in relation to launching products on the market, and this has been a key growth driver so far. Given the competitive nature of this market, with hyperscale customers looking to adopt the best technology available in the market, any delays in relation to competitive product launches are likely to hurt revenue growth. Conclusion  In conclusion, I reiterate my buy rating for CIEN. While customer inventory absorption was slower than expected, there are signs indicating the worst is over (end customer inventory levels are declining and CIEN saw sequential improvements in service provider revenue and orders). I believe CIEN is well-positioned to capture market share with its first-mover advantage in launching innovative products. Additionally, rising demand for AI and machine learning necessitates telecom players to invest in better optical networks, placing CIEN in a prime spot to benefit.","kind":null,"is_publish_news":true,"is_publish_highlight":false,"is_publish_live":null,"is_publish_wemedia":null,"editions":null,"column":"","sentiment":"","news_tag":"","news_rank":0,"symbols":[],"gpt_button":1},"commentList":[],"isCommentEnd":true,"newsSizeData":{"likeSize":0,"commentSize":0,"repostSize":0,"favoriteSize":0,"likeStatus":false,"favoriteStatus":false},"APP":{"userAgent":"Mozilla/5.0 AppleWebKit/537.36 (KHTML, like Gecko; compatible; ClaudeBot/1.0; +claudebot@anthropic.com)","isDev":false,"isTTM":true,"deviceId":"web-server-community-laohu8-v3","version":"4.24.2","shortVersion":"4.24.2","platform":"web","vendor":"web","appName":"ttm","isIOS":false,"isAndroid":false,"isTiger":false,"isTHS":false,"isWeiXin":false,"isWeiXinMini":false,"isWeiBo":false,"isQQ":false,"isBaiduSwan":false,"isBaiduBox":false,"isDingTalk":false,"isToutiao":false,"isOnePlus":false,"isHuaWei":false,"isXiaomi":false,"isXiaomiWebView":false,"isOppo":false,"isVivo":false,"isSamsung":false,"isMobile":false},"href":"/m/news/2444429802"}