This week we are presenting to our community another US (small cap) company benefitting from the boom in optical components. After having recently presented the success story of Coherent Inc., our Market Screener uncovered another high growth company that is well positioned to benefit from the ever-increasing need for bandwidth and data transmission speed.
Fabrinet is a global leader in engineering services, advanced packaging & precision manufacturing for optical components as well as industrial lasers & sensors. The company has factories in Thailand, China, New Jersey, California and United Kingdom. Since the companys creation in 2000, it has created a unique positioning for itself by offering on-demand production of high complexity products, such as optical components and sensors in any mix and volume.
Fabrinet was founded in 2000 by David Mitchell, one of the co-founders of Seagate Technology. Mr. Mitchell founded Fabrinet with $1 million of his own capital as a service provider for the manufacturing of complex optical components. The company was set up to serve original equipment manufacturers on a contract basis.
While Fabrinet facilities look and feel like other internal manufacturing operations, it is actually positioned quite differently by offering a highly flexible yet low-cost environment as well as a variety of turnkey services that are required to support full-service contract manufacturing. Fabrinet covers the full spectrum of what clients need with fully equipped test and calibration labs, built-in quality processes and controls that ensure reliability of products at the highest possible yields.
Fabrinets business took off when it took over Seagates lease of its Thailand based manufacturing site with Seagate becoming one of Fabrinets first customers.
Fabrinets Founder and CEO David Mitchell, Source: Fabrinet
Fabrinet now is a highly trusted manufacturing partner of the worlds most demanding OEMs (original equipment manufacturer). Its panel of customers includes technological leaders from a diverse array of markets ranging from aerospace, automotive, industrial, and laser products to medical, life science, and optical electronics.
For each market, Fabrinet has developed industry-leading capabilities in new product introduction, product industrialization, continuous process improvement, and supply chain management. In addition, Fabrinet offers full product lifecycle support across a range of high-mix, high-value, and complex products.
The following provides an overview of Fabrinets large product portfolio and scope of competence:
➢ Optimal communications: Transceivers, transponders, optical amplifiers, ROADM, silicon photonics
➢ Industrial lasers: Fiber lasers, solid state lasers, semiconductor-based lasers, gas lasers
➢ Auto/sensors: Safety & control sensors, pressure sensors, temperature sensors, gas sensors
As shown by the following chart, the prospects of the optical component market are extremely promising. Thanks to cloud computing, social networking, hyper connectivity and the Internet of Things, the optical component market is expected to grow at rate of 9% per annum through 2020. Specifically, demand is driven by telecom networks looking for a transmission speed of 100Gbps, data centers, etc.
Fabrinet is very well positioned to benefit from this buoyant growth, which has been evidenced over the past few quarters by growth in both already existing programs and the acquisition of new programs.
➢ Sweet spot of accelerating momentum in revenue and profit, as evidenced by the last quarters revenue coming in 5% above the top end of guidance
➢ Broad product and service line up in a large and fast-growing market (Optical Component Market)
➢ Differentiated business model with significant barriers to entry both in terms of expertise and reputation/track record
➢ Low cost manufacturing foot print: over 95% of the companys 10,000 employees is located outside of the US
➢ Attractive valuation with a 2018 PE ratio of 13.2x, also reflected by the 15% upside to the average analyst price target
Risks and Potential Weaknesses
On the most recent earnings conference call, the founder and CEO David Mitchell announced that succession planning had been initiated (due to his advanced age). While there was no concrete timeframe to this process, the search for a new CEO both internally and externally has commenced. This upcoming change carries potential risks und certainty for the companys future. It is however mitigated by the fact that Mr. Mitchell will continue to occupy a leadership role at the company for an undefined period of time after stepping down as a CEO.
With the majority of production capacity situated in Thailand, Fabrinet is exposed to a certain degree of political risk as Thailand has had its fair share of political unrest and upheaval. To date, political turbulence in Thailand has always been contained and has not had a significant impact on foreign investors and investment. In fact, in light of the political uncertainty surrounding foreign trade in the US, Fabrinets strong presence abroad can be considered an asset.
With a PE ratio of 13.2x on projected 2018 earnings, Fabrinet clearly looks undervalued based on future earnings in light of its current earnings and revenue growth momentum. The market fundamentals are very solid so that the high demand for Fabrinets products and services can be expected to persist for a number of years. Given that other growth companies in the optical components sector though not perfectly comparable due to differences in business model and capitalization such as Coherent trade at a 2018 forward PE ratio of 25x, Fabrinet should obtain a more ambitious valuation over time. A presumed PE ratio of 18x to 20x would yield a stock price of between $ 65 and $ 73, reflecting upside of 36% to 52%.
The real-money trading portfolio of 4-traders.com currently owns 125 shares in Fabrinet, which were acquired on 3 January 2017.