Massive Cloud Spending by Microsoft Bullish for 5 Top Optical Stocks

When a tried-and-true old-school technology stock like Microsoft Inc. (NASDAQ: MSFT) is hitting all-time highs, the company must be doing something right. A large part of the company’s recent success has been its strong position in the cloud. Microsoft has become a clear number two in the public or hyper-scale cloud infrastructure market with Azure, which is the company’s cloud computing platform offering.

Azure has become a solid rival to Amazon’s AWS service. Some analysts feel that Microsoft is discounting Azure for large enterprises, so that Azure may be cheaper than AWS for larger users.

A new Stifel research report focuses on the spending by Microsoft to maintain and grow Azure. While the capital expenditures for the recently reported quarter declined year over year, they were up 37% sequentially. The report noted this:

Management highlighted the increase in capital expenditures as resulting from following the company’s strategy of building out capacity (data centers and servers) to meet both near-term and long-term commercial and consumer cloud demand. Looking forward, management called for growth in capital investments to continue meeting growing demand and capacity needs. Fiscal first quarter for 2018 capex was guided to be flat quarter over quarter on an accrual dollar basis. For fiscal year 2018, management anticipates capital investments to increase year-over-year, although spending will remain variable quarter-to-quarter.

Five top stocks are expected to be beneficiaries of the huge spending.

Ciena

This company has had a very up and down 52 weeks and has frequently been the subject of takeover rumors. Ciena Corp. (NASDAQ: CIEN) is a vendor for high-capacity optical transport and Ethernet switching equipment to carriers, enterprises, cable operators and governments. It specializes in transitioning legacy communications networks to converged, next-generation architectures capable of efficiently delivering a broader mix of high bandwidth services.

The company’s Converged Packet Optical segment offers networking solutions optimized for the convergence of coherent optical transport, Optical Transport Network (OTN) switching and packet switching. Its products comprise the 6500 Packet-Optical Platform, 5430 Reconfigurable Switching System, CoreDirector Multiservice Optical Switches and OTN configuration for the 5410 Reconfigurable Switching System.

Ciena remains a top pick due to an expected multiyear ramp in 100G optical spending, which should continue to accelerate in 2017. The analysts note in the report that Ciena’s Waveserver and Data Center Interconnect revenues are estimated to represent low single-digits and 5% to 10% of total revenue. They also see good traction on major deals like Jio in India that should act as a tailwind in 2017.

The stock is rated Buy, and the Stifel price target is $32. The Wall Street consensus target is $30.89, and shares closed Tuesday at $26.80.

Finisar

This stock was hit hard back in March and may still be offering a very good entry point for investors. Finisar Corp. (NASDAQ: FNSR) provides optical subsystems and components for data communication and telecommunication applications in the United States, Malaysia, China and internationally.

Its optical subsystems primarily consist of transmitters, receivers, transceivers, transponders and active optical cables that provide the fundamental optical-electrical or optoelectronic interface for interconnecting the electronic equipment used in communication networks, including the switches, routers and servers used in wireline networks, as well as the antennas and base stations used in wireless networks.

The company also offers wavelength selective switches, which are used to switch network traffic from one optical fiber to multiple other fibers without converting to an electronic signal. In addition, it provides optical components comprising packaged lasers, receivers and photodetectors for data communication and telecommunication applications, as well as passive optical components for telecommunication applications.

The analysts note that Finisar has the highest exposure to datacom in their coverage, and the company likely will benefit from solid long-term data center demand trends.

The stock is rated Buy at Stifel, which has a price target of $33. The consensus target is $37. Shares closed Tuesday at $28.37.

Lumentum

This top company looks to benefit big-time from the Azure project. Lumentum Holdings Inc. (NASDAQ: LITE) manufactures and sells optical and photonic products in the Americas, the Asia-Pacific, Europe, the Middle East and Africa. Its Optical Communications segment offers components, modules and subsystems that enable the transmission and transport of video, audio and text data over high-capacity fiber optic cables.

The analyst report noted that the company generates about 18% of the total revenue from datacom. The stock has surged since May as the expectations for 3D sensing and the company having a big part in the new iPhone 8 were the driving force behind the sharp gains. The CEO recently said they are working on several handset OEMs for 3D sensing and he could see $100 million or so a quarter growing up to a $1 billion opportunity annually.

Stifel has a Buy rating and a $73 price target, while the consensus target is $64.07. Shares closed on Tuesday at $66.95.

Oclaro

This is a smaller capitalization company that may offer big upside potential. Oclaro Inc. (NASDAQ: OCLR) designs, manufactures and markets lasers and optical components, modules and subsystems for the optical communications, industrial and consumer laser markets worldwide.

The company’s products generate, detect, combine and separate light signals in optical communications networks. It offers client side transceivers, including pluggable transceivers; line side transceivers; tunable laser transmitters, such as discrete lasers and co-packaged laser modulators; lithium niobate modulators to manipulate the phase or the amplitude of an optical signal; transponder modules for transmitter and receiver functions; and discrete lasers and receivers for metro and long-haul applications.

The analysts note that Oclaro has a staggering 49% of total revenue generated from datacom. While the exposure could hurt in a downturn, the current positive momentum bodes well for the future.

The Stifel price target for the Buy-rated shares is $12. The consensus target is $12.64, and shares closed Tuesday at $10.30.

Infinera

Some feel this top company would be an outstanding addition to a networking giant as a takeover candidate. Infinera Corp. (NASDAQ: INFN) provides Intelligent Transport Networks, enabling carriers, cloud operators, governments and enterprises to scale network bandwidth, accelerate service innovation and simplify optical network operations. Infinera’s end-to-end packet-optical portfolio is designed for long-haul, subsea, data center interconnect and metro applications. Infinera’s unique large-scale photonic integrated circuits enable innovative optical networking solutions for the most demanding networks.

The Stifel report notes that Cloud Xpress revenue is expected to be about 12% of the company’s total revenue, while total Data Center Interconnect revenue is expected to be 20% to 25% of the total.

The stock is rated Neutral, with a $10 price target. The consensus target price is $11.90. Shares closed above both levels on Tuesday at $12.21.

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The Stifel analysts, like most on Wall Street, remain very positive on cloud spending growth going forward with most citing 100G adoption as one of the biggest factors. While these stocks are only suitable for aggressive growth accounts, they all make solid additions at current trading levels.