Bernstein remains bullish on Lumentum (LITE.US) and Coherent (COHR.US) after sharp stock price pullbacks, reiterating "Outperform" ratings.

Bernstein said in its latest research report that although AI-related stocks have generally come under pressure recently, with optical communications equipment makers Lumentum (LITE.US) and Coherent (COHR.US) falling 13% and 28% respectively over the past month, the main factors driving the selloff have not materially changed the fundamentals of the optical communications industry. The firm remains bullish on the two companies' long-term growth prospects in the wave of AI infrastructure buildout, reiterates "Outperform" ratings on both stocks, and maintains price targets of $1,220 and $350, respectively. Bernstein noted that the recent pullback in the AI sector has been affected by multiple factors, including weak revenue performance at some AI labs, financing issues at CoreWeave (CRWV.US), profit-taking after the Open Compute Project (OCP) summit, earnings previews that did not show significant room for upside surprises, and deterioration in the macroeconomic environment. Among these, slowing AI lab revenue, financing pressure, and the macroeconomic environment are more important stock price drivers, but these issues do not necessarily mean that demand for AI infrastructure is weakening in tandem. The firm believes that revenue pressure at some AI labs may be related to changes in the competitive landscape and the growing adoption of open-weight models, rather than a fundamental reversal in compute demand across the entire AI industry. As long as AI model performance continues to improve and application penetration continues to expand, tech giants will still have incentives to invest in next-generation model training and related infrastructure, thereby supporting long-term demand for high-speed optical modules, optical components, and optical interconnect systems. It is worth noting that Bernstein believes the real long-term debate in the optical communications industry is not whether AI demand will grow, but whether future demand expansion can the revenue and profit currently expected by the market. According to the firm's estimates, the NVIDIA Corporation (NVDA.US) Vera Rubin NVL72 architecture's NVLink scale-up bandwidth reaches 216TB/s, while scale-out network bandwidth is 32.4TB/s, with the former about 7 times the latter. At the same time, supply chain surveys show that the unit bandwidth prices of 1.6T pluggable optical modules and 3.2T co-packaged optics (CPO) solutions are approximately $0.48 and $0.44 per Gbps, respectively. If future rack architectures can maintain similar bandwidth ratios and unit bandwidth prices, then the potential market opportunity corresponding to scale-up CPO could be about 6 times that of the existing scale-out pluggable optical module market. This means that even if CPO penetration in scale-up networks remains limited in 2028, it could still bring significant revenue growth space for optical communications vendors. However, Bernstein emphasized that the above estimates are highly dependent on unit bandwidth prices remaining relatively stable, and this assumption is controversial. Historically, unit bandwidth prices for optical communications products have generally declined with technological progress, and the current relatively strong pricing environment is partly benefiting from an indium phosphide (InP) supply bottleneck. Bears worry that as InP capacity continues to expand, and as technologies that do not rely on InP, such as VCSEL and Micro-LED, or continuous-wave lasers that use less InP, gain more applications, industry supply-demand relationships may change, thereby weakening the pricing power and profit margins of optical communications products. Bernstein believes that this debate over long-term demand, technology routes, and supply constraints is unlikely to be resolved in the upcoming quarterly earnings reports, but recent industry news has been generally positive and may prompt the management of both companies to release more optimistic business outlooks. Among these, NVIDIA Corporation is moving up the application timetable for CPO technology to 2027, with plans to adopt related technology in inter-rack scale-up networks; Microsoft Corporation's Maia architecture uses optical switching technology to connect 128 racks, building a supercomputing cluster containing 12,288 accelerators. In addition, both Lumentum and Coherent have demonstrated PCIe interconnect solutions based on VCSEL optical technology, and Coherent has also launched the PhotonLink product, further indicating that optical interconnect technology is expanding into more AI computing scenarios. Regarding the upcoming earnings reports, Bernstein expects Coherent's results to potentially exceed market consensus. The firm forecasts first-quarter fiscal 2027 revenue of about $2.372 billion, up about 50% year over year, near the upper end of the company's guidance range of $2.2 billion to $2.4 billion, and above the market expectation of $2.309 billion; adjusted earnings per share are expected to be $2.05, also above the market expectation of $1.99. Bernstein expects Coherent's gross margin for the quarter to reach 41%, up 80 basis points quarter over quarter. For the second quarter of fiscal 2027, the firm forecasts revenue will further increase to $2.613 billion and adjusted earnings per share will reach $2.28, both above market consensus. This means management may provide next-quarter guidance above market expectations when releasing results. However, Coherent's margin performance remains a focus for investors. Bernstein noted that although the company is expanding 6-inch wafer capacity, the related cost advantages have not yet been fully reflected in margin improvement. The firm believes this is related to Coherent's business model. Compared with Lumentum, which sells more upstream components to Chinese optical module manufacturers, Coherent sells more complete optical transceiver modules and has to bear the relatively lower-margin assembly segment, so rapid revenue growth may not necessarily bring profit expansion of the same magnitude. If management can further explain the profit contribution from the 6-inch wafer capacity expansion, it would help alleviate market concerns. For Lumentum, Bernstein expects first-quarter fiscal 2027 revenue of about $1.254 billion, up about 135% year over year, and adjusted earnings per share of $4.18, basically in line with market consensus. The firm expects the company's gross margin for the quarter to rise to 52% from 50.4% in the previous quarter, with an operating margin of 40%. Bernstein believes Lumentum's second-quarter earnings have more obvious upside potential, forecasting revenue of $1.497 billion and adjusted earnings per share of $5.15, above market expectations of $1.477 billion and $5.04, respectively. However, because Lumentum management has previously set a target of achieving $40 in earnings per share capability by 2028, the market's focus may shift more toward long-term growth drivers, especially the commercialization prospects of the optical circuit switch (OCS) business. Based on supply chain information, Bernstein estimates that Lumentum's OCS solution costs about $600 per port, corresponding to about $150,000 in equipment value per rack for Alphabet Inc. Class C TPU v7 Ironwood. Assuming TPU v7 deployments reach 2.6 million units in 2026 and each rack is equipped with 64 TPUs, this platform alone could create a potential OCS market opportunity of about $6 billion. However, the firm emphasized that this does not mean Lumentum can capture all related revenue. Because its OCS solution cost is significantly higher than the Celestica contract manufacturing solution previously used by Alphabet Inc. Class C, Bernstein remains uncertain about the specific reasons why Alphabet Inc. Class C is turning to Lumentum, and it is difficult to accurately judge how much market share the company can ultimately obtain. On valuation, Bernstein noted that the recent stock price pullback has further improved Coherent's valuation attractiveness relative to Lumentum. Although the firm previously preferred Lumentum, as the valuation gap between the two companies has widened, it no longer clearly favors either company. According to the report, as of October 19, Lumentum's stock price was $834.51 and Coherent's was $232.02. Based on Bernstein's maintained price targets of $1,220 and $350, the two companies have potential upside of about 46% and 51%, respectively. Bernstein believes that short-term earnings may not completely dispel market concerns about InP supply, CPO technology routes, and long-term profitability, but if the two companies can deliver solid results and release positive signals on next-quarter demand, it would help restore investor confidence in the AI optical communications supply chain. The firm therefore continues to maintain a positive view on both companies and believes the current stock price pullback has not changed their long-term investment logic.