Summary
- Ciena saw strong data center growth offset by weaker service provider demand, with significantly better margins on business mix and cost/efficiency improvements.
- Covid-19 could tap the brakes on data center growth in the second half, but the long-term story remains strong with the 800G ramp just beginning.
- Ciena looks more fairly valued than undervalued to me now, but execution on share growth opportunities could still generate upside and management is building a good track record.
Not all suppliers to data center customers (particularly hyperscale customers) are benefitting equally, but I’d say on balance that it’s pretty clear that data center spending is still a strong driver for leading vendors like Broadcom (AVGO), Inphi (IPHI), and Ciena (CIEN), with the latter’s share price up about 20% from the time of my last article. While Ciena’s performance relative to other optical equipment companies (including Cisco (CSCO), Infinera (INFN), and Nokia (NOK)) hasn’t been the strongest over the past three months, the one-year and two-year comparisons are more favorable, as Ciena has been riding a winning strategy for some time now.
I still believe that many of the key drivers for Ciena are firmly in place – potential share gains from rivals like Huawei and Nokia on the server provider side, ongoing growth in its webscale business, and relatively few meaningful competitors in that cloud/hyperscale market. Valuation is more challenging now; I don’t think Ciena is overpriced here, but I do see sell-siders stretching to validate ever-higher target prices, and I think upside is now tied more to outperforming a higher bar of expectations rather than convincing investors to reconsider Ciena’s positive qualities.
Better Margins Drive A Fiscal Q2 Beat
Ciena’s fiscal second quarter revenue was only a little better than expected, but gross and operating margins were significantly better than expected, beating sell-side estimates by almost four points and five-and-a-half points, respectively. Guidance for the remainder of the year was not necessarily that bullish on the top line, but higher margins are welcome and Ciena is establishing a pretty good reputation for conservative guidance (meaning there could still be some upside).
Revenue rose more than 3% YoY and 7% QoQ in the fiscal second quarter, with software and services outperforming products on a YoY basis (up 14% versus up 1%), while the reverse was true on a QoQ comparison (up 1% and up 9%, respectively). Converged packet optical products saw 5% YoY and 11% QoQ growth, with that growth driven principally by data center customers. Overall webscale revenue grew 28% YoY, beating expectations.
Gross margin improved three points from the year-ago level and almost two points from the prior quarter, with product gross margin up more than three points YoY and almost two points QoQ. Ciena benefited from ongoing process/cost improvement efforts, as well as a mix shift away from newer accounts (new business tends to come with meaningfully lower initial gross margins). While I do not endorse this view, I wouldn’t be surprised to see a few Ciena bears try to cast this in a negative light, suggesting that new business win activity is flagging. My own view is that the business is becoming more diversified (only one 10%+ customer) and Ciena is growing past a point where those new wins have the same negative impact on margins as before.
Ciena’s liquidity/cash situation is fine, and I see no issues with Ciena maintaining adequate liquidity and balance sheet flexibility through the Covid-19 pandemic and its aftermath.
