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Why This Tech Stock Has More Upside

June 22, 2014 | About:
FinanceGuru

FinanceGuru

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Finisar (FNSR) is a leading provider of optical subsystems and components for telecom and data communication applications. The stock has roughly doubled over the past year, fueled by a strong secular demand for optical equipment (driven by the build-out of high-speed LTE networks) coupled with a compelling market-share gain story. With the stock off slightly from its 52-week highs, it's worth taking a closer look at this market leader.

Compelling product and customer base
Finisar appears to have one of the broadest product portfolios in the industry. While the firm does have a number of potent competitors, notably JDS Uniphase (JDSU) in the telecom space and Avago (AVGO) in the datacom space, it appears that no other company matches the breadth of Finisar's product offerings across both of these segments.

Source: Finisar.

Now, lest one think that Finisar's offerings are broad but not deep, the company has seen steady share growth over the past 10 years and -- according to a December 2013 Ovum market study -- is currently the market share leader, with 16% of the market. This puts it well ahead of Avago, which has 9.7% share and JDS-Uniphase, with 8.6% share.

Source: Finisar.

A secular growth market
While a broad product portfolio and strong competitive position are certainly compelling, investors would be remiss to ignore the underlying secular trends -- a good house is worth a lot less in a bad neighborhood. However, so far the pretty aggressive build-out of next-generation telecom infrastructure, as well as just the absolute explosion of data necessitating the continued growth in the data-center (helping Finisar's datacom business) have been good to Finisar, as the revenue picture suggests.

Source: Finisar.

As a result of the compelling revenue picture, Finisar has seen rather tremendous leverage, with gross margins up 690 basis points year over year in the most recent quarter and operating margins roughly tripling over that same timeframe. This has driven rather substantial EPS growth and explains the doubling of the share price. However, while this picture looks rosy, there are some things worth considering.

What could go wrong?
Watchers of Finisar's shares have probably noticed some pretty extreme volatility in the stock price. This is reflected in the stock's beta, which comes in at 2.06, implying that the shares are about twice as volatile as the rest of the market. This is probably due in no small part to the fact that the number of sales sold short (remember that selling a stock short means that an investor is betting on a price decline) is a fairly high percentage of the total shares outstanding (17%, to be more precise).

Furthermore, the number of shares shorted continues to rise and is at the highest level seen during the past year. What is likely fueling that short interest is a bet that Finisar's recent growth spurt is merely cyclical and once the big network build-out cycle is complete, revenues will fall off, leverage will go away, and the shares go from looking fairly cheap to downright expensive.

Some historical perspective and outlook
To put this into perspective, Finisar reported $948.8 million in sales during fiscal 2011 and record non-GAAP net income of $138 million. In fiscal 2012, revenues inched up slightly, but gross margins declined to 31.9% from 34.8% in the prior year. On top of that, increased operating expenses in the face of an anemic revenue growth picture and lower gross margin drove a substantial loss of leverage.

The good news, though, is that the explosion in data traffic thanks to the rise of mobile devices (which has dramatically juiced up Internet traffic), Internet streaming (particularly as bandwidth improves and higher-resolution video can be streamed), and cloud services doesn't seem anywhere close to over. For example, much of the world still has to transition to 4G LTE from the fairly low 3G data-rates, and developed countries will transition to faster LTE-Advanced and beyond speeds. This secular trend is exceptionally powerful, and while nothing lasts forever, it should have a lot more legs than even the original Internet boom itself.

Source: Finisar.

Conclusion
Finisar is the market leader and is gaining share in a rather compelling secular growth market. While the stock isn't all that far removed from its 52-week highs, this is definitely a stock worth putting on your watchlist. And, should a broad market correction create a buying opportunity in tech equities, Finisar is definitely an interesting way to play the continued explosion in worldwide data traffic.


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