What happened
Shares of optical communications and industrial laser stock Coherent (COHR 1.87%) rose 37.9% in June, according to data from S&P Global Market Intelligence.
There were two reasons behind Coherent's fantastic month. First, the company caught the AI wave, as Coherent has a leading position in optical transceivers for AI data center networking. Second, the company also introduced new industrial laser products that could greatly increase power and efficiency for industrial welding and cutting applications.
So what
Like most semiconductor stocks, Coherent saw demand destruction last year coming off the pandemic digitization push and higher interest rates. So, Coherent was already trading significantly below its 2021 highs coming into June -- as in, nearly 70%.
Coherent also has debt concerns. Today's Coherent was formed when II-VI acquired Coherent in a debt-fueled transaction that closed exactly one year ago. Unfortunately, II-VI used a significant amount of floating-rate debt in the transaction, just as the Federal Reserve quickly raised interest rates -- making an already-expensive acquisition even more expensive.
With the stock depressed, Coherent was therefore primed for a bounce on any sign of optimism. That sign came with Nvidia's blowout guidance in late May, fueling optimism over any stock related to the AI ecosystem.
Coherent could be an AI beneficiary, as it's a leader in optical transceivers -- components that fuel lightning-fast communications within and between data centers. Back in March, Coherent demonstrated 200 gigabit-per-second (Gbps) per optical lane technology, which will go into its next-gen 800 Gbps and 1.6 terabyte-per-second optical transceiver modules. It's thought that AI will accelerate demand for these high-capacity optical connections, and that Coherent will benefit.
In addition to optical communications, another large end market for Coherent is industrial lasers, which are increasingly used for cutting and welding in next-gen applications like electric vehicle batteries, medical devices, OLED display manufacturing, and semiconductor capital equipment.
In June, Coherent unveiled several new products in the industrial laser space under its Powerline FL series. The Powerline series of lasers are "cost-efficient, fully configured, simple to integrate subsystems that offer a compelling cost of ownership model," according to the press release.
As the cost and complexity of industrial lasers decreases, lasers should find more ways to replace conventional tools across a wide array of applications. So in addition to the optimism over AI data center networking, optimism for industrial lasers likely aided the stock's June rise. This is especially true as U.S. domestic manufacturing appears robust, with several already-passed bills aimed at incentivizing U.S. manufacturing taking hold.
Now what
With exposure to AI and electrification, some may think Coherent is a no-brainer; however, unlike some other stocks in the space, there's an additional risk here having to do with the company's debt. As mentioned before, II-VI paid a pretty penny for Coherent before renaming the business, and took on high-yielding debt, floating-rate debt, and dilutive convertible notes to fund the acquisition.
While Coherent management does believe it will achieve a lot of synergies and often touts the company's significant operating income, it often does so with respect to adjusted (non-GAAP) numbers. But with a fair amount of stock-based compensation and high and rising interest costs, Coherent's bottom line doesn't look good at all. In fact, last quarter it still lost ($33.5 million) on a GAAP basis.
After June's run, bullish investors are counting not only on a demand reacceleration, but likely interest rate cuts as well -- both of which may or may not happen to the extent investors want. So, I would proceed with caution with respect to Coherent.