A Downgrade Wounded AAOI Stock, but Trump Could Kill It

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AAOI stock - A Downgrade Wounded AAOI Stock, but Trump Could Kill It

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Optical device and component manufacturer Applied Optoelectronics (NASDAQ:AAOI) has suffered tremendous choppiness over the past two years. Unfortunately, things got even more wild in the past 24 hours, with AAOI stock losing 9.5% in the markets.

Wall Street took an extremely dim view on the optics firm when Loop Capital Markets’ analyst James Kisner downgraded Applied Optoelectronics stock from a “hold” rating to a “sell.” Kisner also lowered the his price target to $20, which represents over a 29% loss from the current market value. Previously, the analyst held a price target of $45.

The dramatic shift in sentiment came from quality-control issues with the company’s 100G CWDM4 transceivers. Specifically, the laser component within the transceivers have failed after only thousands of operating hours.

Given the competitive nature of the optical-device sector, these issues could cause Applied Optoelectronics to lose market share. That in turn would result in sharp losses for AAOI stock.

Adding to the woes, Loop Capital interviewed industry experts regarding the optics sector. They informed the research firm that the pricing situation for 100G CWDM4 data center optics is extremely challenged.

Loop Capital previously forecasted that average selling prices for these specialized optics at $250 a pop by September next year. However, the expert consensus now sees $200.

The obvious worry for AAOI stock is the margins. Currently, the company enjoys double-digit operating and net margins. According to Gurufocus.com, Applied Optoelectronics ranks in the top-third among global semiconductor firms for profitability margins.

Such strong margins have also helped AAOI look attractive on a valuation basis. For example, Applied Optoelectronics stock trades at 16-times trailing earnings, and under 12-times forward earnings. But that advantage declines significantly if their core product’s ASP drops 20%.

AAOI Stock Faces Intense Pressure

Of course, Applied Optoelectronics stock didn’t just tank based on one analyst’s assessment. Other market professionals have voiced similar concerns. After all, AAOI started the month of September by dropping 11%!

Moreover, on a year-to-date basis, shares are down 25%. And AAOI stock has spent more months this year in the red than in the black. Clearly, the markets have voiced concerns for a while, testing contrarians’ patience.

My belief is that their faith in the optics specialist will continue to be tested. Its last earnings report for the second quarter was particularly telling. Profitability margins from the top down fell significantly. Against the year-ago level, gross margins fell by 15%, while operating and net margins dropped 65% and 63%, respectively.

The thing is, AAOI’s Q2 report was released at the beginning of August. That’s well before the time that President Trump ramped up our conflict with China through $200 billion worth of tariffs. The Chinese government in turn responded with $60 billion in retaliatory tariffs.

Since then, AAOI stock has remained choppy because of our ongoing trade war with the Asian juggernaut. However, the rapidly-spiraling situation hits the company in the solar plexus because it has a strong presence in Asia. Specifically, it has facilities in Taiwan and China.

As The Motley Fool contributor Nicholas Rossolillo reported, management is well aware of the geopolitical dilemma. It has the option to shift manufacturing to other places.

However, Applied Optoelectronics set up shop in China for cheap labor. Getting out of China and into another country will surely increase labor costs, exacerbating the margin-decline problem.

And management can talk all they want about diversifying revenue streams. At the end of the day, it’s going to be a tall order to do tech without China. This is where additional complications grow.

Political Circus Could Spell Doom

When diplomats from the U.N. General Assembly laughed at President Trump, many viewed the moment as cathartic. They really should have viewed it as a threat.

Donald Trump does not take kindly to mockery. That’s why he does it to others via Twitter (NYSE:TWTR), and various media platforms. He lashes out at others to protect his own vulnerability or perhaps fragility.

After that embarrassing fiasco, do you think he’s going to brush it off? No. I recall an old episode of The Apprentice in which then-real estate mogul Trump stated that he hated his enemies. This is not a forgive-and-forget type of person.

Which is why the China tariffs is likely to worsen. Trump appeared very soft and conciliatory towards Russian President Vladimir Putin. Now, the U.N. laughed at him. He has to act tough to both save face and reestablish credibility with his conservative base. China is the perfect scapegoat.

That’s why I think you should take the markets’ hint and pass on AAOI stock. Yes, it’s on discount, but it could get even cheaper.

As of this writing, Josh Enomoto did not hold a position in any of the aforementioned securities.

A former senior business analyst for Sony Electronics, Josh Enomoto has helped broker major contracts with Fortune Global 500 companies. Over the past several years, he has delivered unique, critical insights for the investment markets, as well as various other industries including legal, construction management, and healthcare. Tweet him at @EnomotoMedia.


Article printed from InvestorPlace Media, https://investorplace.com/2018/09/trump-could-kill-aaoi-stock/.

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