Last July, II‐VI Inc. acquired Coherent (COHR 4.12%) and took over its name and ticker. The acquisition created a larger and more broadly diversified manufacturer of optical materials, lasers, and semiconductors, and it initially gained a lot of attention from the bulls with the growth potential of its AI-related equipment and silicon carbide businesses.
However, Coherent's stock plummeted in August after it followed up its fiscal fourth-quarter earnings beat with a softer-than-expected forecast for the first quarter of fiscal 2024 (which started on July 1). As a result, Coherent's stock remains nearly flat over the past 12 months.
Let's see where this divisive stock might be headed in a year.
Image source: Getty Images.
Look beyond its inorganic growth
Coherent's revenue surged 56% to $5.16 billion in fiscal 2023, but most of that growth came from II-VI's acquisition of the original company. Its networking revenue rose 7% to $2.34 billion while its materials revenue grew 21% to $1.35 billion. It generated $1.47 billion in laser revenue, which came entirely from its acquisition of the old Coherent.
But if we strip out that inorganic growth, its numbers look a lot less impressive. Its revenue actually declined sequentially over the past two quarters, while its adjusted gross and operating margins contracted throughout fiscal 2023.
|
Metric |
Q1 2023 |
Q2 2023 |
Q3 2023 |
Q4 2023 |
|---|---|---|---|---|
|
Revenue |
$1.34 billion |
$1.37 billion |
$1.24 billion |
$1.21 billion |
|
Adjusted gross margin |
40.3% |
39.8% |
37.3% |
35.9% |
|
Adjusted operating margin |
21.3% |
20.3% |
17.5% |
15.4% |
Data source: Coherent.
Coherent expects to generate $1.01 billion to $1.1 billion in revenue in the first quarter, which would represent its third sequential drop and an 18% to 25% decline from a year ago. For the full year, it expects its revenue to slide 9% to 13% to between $4.5 billion and $4.7 billion.
Why is Coherent's growth cooling off?
Coherent attributed that slowdown to macro headwinds across the industrial, instrumental, and consumer electronics markets; the post-pandemic-emergency slowdown of the communications market; and its sluggish recovery in China.
All of those challenges offset its rising sales of AI-oriented products. Its silicon carbide chips recently gained a lot of attention for their ability to replace traditional silicon chips by operating at higher temperatures and frequencies -- but they only accounted for 6% of its revenue in its latest quarter.
On the bright side, Coherent expects its adjusted gross margin to rise from 38% in fiscal 2023 to between 37% and 42% in fiscal 2024. That potential expansion suggests it can still maintain its pricing power as it pivots away from some of its legacy products. But it still expects its adjusted EPS to plunge 81% to 95% year over year in the first quarter of fiscal 2024 and to decline 50% to 67% for the full year as it grapples with its slower revenue growth and elevated operating costs.
Coherent's revenue and earnings might stabilize once the macro environment improves, but CEO Chuck Mattera warned investors during the latest conference call that it "will not see meaningful signs of recovery before the end of fiscal '24."
Does Coherent have any near-term catalysts?
Coherent expects its sales of 800G datacom transceivers for artificial intelligence (AI) and machine learning purposes to offset the slower growth of its legacy products throughout fiscal 2024. It's also been exploring "strategic alternatives" for its growing silicon carbide business, which currently operates as an independent subsidiary.
Two Japanese automakers -- Denso and Mitsubishi Electric -- both recently invested a combined $1 billion in the silicon carbide unit to value it at $4 billion. That's a pretty high premium, considering Coherent has an enterprise value of $11 billion and its silicon carbide unit only generates a single-digit percentage of its total sales. If other investors hop aboard the bandwagon, we might just see Coherent spin off the silicon carbide unit as a fresh initial public offering (IPO).
Where will Coherent's stock be in a year?
But for now, Coherent's stock isn't cheap at 10 times this year's sales. Its growth is slowing and it ended fiscal 2023 with an elevated debt-to-equity ratio of 1.3. Those weaknesses will limit its upside potential in a high interest rate environment. Based on these challenges, I believe Coherent will continue to underperform the market over the next 12 months. It's also easy to find higher-growth plays on the AI and silicon carbide markets that aren't heavily burdened by legacy businesses.
