Applied Optoelectronics Inc (AAOI) Stock Looks Like a Steal Under $50
Applied Optoelectronics Inc (NASDAQ:AAOI) stock is taking yet another massive leg lower today after the fiber‑optic networking products company pre-announced dismal third-quarter numbers that fell well short of analyst expectations.
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The culprit? Amazon.com, Inc. (NASDAQ:AMZN), Applied Opto’s largest customer, which suddenly and dramatically lowered its spend on AAOI products in the third quarter. The result is that the third quarter revenue and earnings guides got cut by 20% each.
Consequently, AAOI stock is off about 20% in Friday trading.
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But there are many reasons to get bullish on AAOI stock now that it’s down below $50. The stock is dirt cheap, the secular growth story (outside of Amazon) remains intact, there aren’t any signs that this Amazon shortage problem is permanent and the company has now significantly lessened its reliance on Amazon.
All in all, the sell-off in AAOI stock looks like a gross overreaction to ugly near-term news.
This is a great time to accumulate shares before what will likely be a huge run-up in 2018.
Why AAOI Is a Buy on This Sell-Off
We all knew Applied Opto’s third quarter wasn’t going to be pretty. Management told us that on the second-quarter conference call. One big customer (Amazon) was showing signs of softening 40G demand. Consequently, 40G demand slowdown was going to offset 100G demand ramp in the third quarter, and sequential revenue growth would be negative.
Investors freaked out and sold in bunches.
Now, we are getting news that the 40G slowdown from Amazon is even worse than initially anticipated.
Investors are freaking out. Again. And selling in bunches. Again.
But now that AAOI stock has lost about 50% of its value since August, it’s time to start looking at the contrarian buy thesis on Applied Optoelectronics.
That thesis looks quite strong.
For one, the stocks is cheap. Dirt cheap. Even if we slice about 60 cents off of fiscal 2017 earnings estimates (that would imply third-quarter weakness carried over into the fourth quarter, which seems unnecessarily bearish), the consensus fiscal 2017 earnings estimate still stands around $4.72.
At $46, then, AAOI stock is trading at under 10-times bearishly revised 2017 earnings estimates.
A sub-10 price-to-earnings multiple would only make sense if fiscal 2017 earnings were peak cycle. But they aren’t. AAOI is a pure play on the secular growth in hyper-scale data centers (85% of revenues were from data centers in Q2). The hyper-scale data center market is far from peak cycle. This is a market that is expected to grow at a compounded annual growth rate of anywhere between 20% and 25% over the next several years.
AAOI likely won’t grow at that 20% to 25% rate over the next several years because competition will inevitably intensify. But AAOI does look like a lock for at least 5%-10% growth over the next several years due to its leadership position in the market.
Just look at the recent quarterly guide. AAOI lost a whole bunch of revenue from its biggest customer. But even with that lost revenue, revenues are still expected to grow 26% year-over-year. Clearly, demand from other customers remains robust.
That will be the case over the next several years. Plus, AAOI continues to maintain a healthy gross margin profile in the 41% to 45% range while robust revenue growth is allowing for tremendous operating expense leverage.
Bottom Line on AAOI Stock
Right now, AAOI is in transition. Amazon might be ditching AAOI completely, or it may be just hitting the pause button for a while. No one really knows.
But what is clear is that even without Amazon, AAOI is still growing revenues at a 25%-plus clip. Overall, regardless of the Amazon noise, the market demand for hyper-scale data center optical transceivers remains robust.
With AAOI stock trading at under 10x fiscal 2017 earnings, this seems like a perfect time to accumulate before 2018. Once AAOI moves past this Amazon noise in 2018, growth will normalize and AAOI stock will take-off.
As of this writing, Luke Lango was long AAOI and AMZN.
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