Rating Update: Stock Rating D-Negative (8/6/19)-Applied Optoelectronics Inc (AAOI).

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BUSINESS

Applied Optoelectronics, Inc. designs, manufactures, and sells various fiber-optic networking products worldwide. It offers optical modules, lasers, transmitters and transceivers, and turn-key equipment, as well as headend, node, and distribution equipment. The company sells its products to Internet data center operators, cable television and telecommunications equipment manufacturers, and Internet service providers through its direct and indirect sales channels. Applied Optoelectronics, Inc. was founded in 1997 and is headquartered in Sugar Land, Texas.
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INVESTMENT RATING

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AAOI’s future returns on capital are forecasted to fall short of the cost of capital. Accordingly, the company is expected to be a major Value Eraser.

AAOI has a current Value Trend Rating of D (Negative).
This rating combines very contradictory signals from two proprietary PTR measures of a stock’s attractiveness. AAOI has a good Appreciation Score of 74 but a very low Power Rating of 6, and the Negative Value Trend Rating results.

AAOI’s stock is selling well below targeted value. The current stock price of $10.12 compares to targeted value 12 months forward of $18.
This high appreciation potential results in an appreciation score of 74 (only 26% of the universe has greater appreciation potential.)
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AAOI has a Power Rating of 6. (AAOI’s very low Power Rating indicates that it only has a higher likelihood of achieving favorable investment performance over the near to intermediate term than 6% of companies in the universe.)
Factors contributing to this very low Power Rating include: AAOI’s earnings estimates have fallen very significantly in recent months; and recent price action has been extremely unfavorable. An offsetting factor is is currently in a modestly favorable positi.

INVESTMENT PROFILE

AAOI’s financial strength is high. Financial strength rating is 81.
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Relative to the S&P 500 Composite, Applied Optoelectronics Inc has slightly more Value than Growth characteristics; its appeal is likely to be to Capital Gain-oriented investors; the perception is that AAOI is higher risk. Relative weaknesses include: low historical profitability, high stock price volatility, and high earnings variability. AAOI’s valuation is low: low dividend yield, low P/E ratio, and low price/book ratio. AAOI has unusually low market capitalization.

CURRENT SIGNALS

AAOI’s current operations are eroding. Return on equity is falling, reflecting: falling asset utilization; declining pretax margin; falling tax keep rate; and falling leverage.

AAOI’s current technical position is very weak. The stock price is in a 4.2 month down move. The stock has declined 33.5% from its prior high. The stock price is below its 200 day moving average which is in a downtrend.

ALERTS

Applied Optoelectronics Inc (NASDAQ: AAOI) has benefited from extremely meaningful positive changes in investment behavior: its shorter term price trend turned up, and positive upside/downside volume developed.
Applied Optoelectronics Inc (NASDAQ: AAOI) has recently experienced marginal negative changes in fundamentals: significant quarterly earnings deceleration occurred.
The stock is currently rated D.
Applied Optoelectronics Inc (NASDAQ: AAOI) stock suffered a major decline of -24.3% on 8/6/19. The shares closed at $0.02. NORMAL trading volume accompanied the decline. The stock has been extremely weak relative to the market over the last nine months but has risen 9.1% during the last week.

CASH FLOW

In 2018, AAOI experienced a very significant reduction in cash of -$25.98 million (-31%). Sources of cash were much lower than uses. Cash generated from 2018 EBITDA totalled +$30.96 million. Non-operating uses consumed -$9.93 million (-32% of EBITDA). Cash taxes contributed +$7.63 million (+25% of EBITDA). Re-investment in the business amounted to -$90.48 million (-292% of EBITDA). On a net basis, debt investors contributed +$37.88 million (+122% of EBITDA) while equity investors pulled out -$2.04 million (-7% of EBITDA).
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AAOI’s Non-operating Income, %EBITDA has suffered a very strong overall downtrend over the period. This downtrend was accompanied by stability for the Applied Optoelectronics Inc Peer Group. (Since 2016 Non-operating Income, %EBITDA has accelerated sharply.) In most years, AAOI was in the third quartile and top quartile. Currently, AAOI is lower quartile at -32% of EBITDA (-$9.93 million).

AAOI’s Cash Taxes, %EBITDA enjoyed a volatile overall uptrend over the period. This improvement was accompanied by stability for the Applied Optoelectronics Inc Peer Group. In most years, AAOI was in the top quartile and second quartile. Currently, AAOI is upper quartile at +25% of EBITDA (+$7.63 million).

AAOI’s Business Re-investment, %EBITDA has enjoyed a volatile overall uptrend over the period. This improvement was accompanied by stability for the Applied Optoelectronics Inc Peer Group. In most years, AAOI was in the lower quartile. Currently, AAOI is lower quartile at -292% of EBITDA (-$90.48 million).

AAOI’s Debt Investors, %EBITDA has experienced a very strong overall uptrend over the period. This improvement was accompanied by a similar trend for the Applied Optoelectronics Inc Peer Group. (Since 2016 Debt Investors, %EBITDA has decelerated very sharply.) In most years, AAOI was in the top quartile and lower quartile. Currently, AAOI is upper quartile at +122% of EBITDA (+$37.88 million).

AAOI’s Equity Investors, %EBITDA has suffered a very strong overall downtrend over the period. This downtrend was accompanied by a similar trend for the Applied Optoelectronics Inc Peer Group. (Since 2013 Equity Investors, %EBITDA has decelerated very sharply.) In most years, AAOI was in the top quartile. Currently, AAOI is slightly above median at -7% of EBITDA (-$2.04 million).

AAOI’s Change in Cash, %EBITDA has experienced a very strong overall downtrend over the period. This downtrend was accompanied by stability for the Applied Optoelectronics Inc Peer Group. In most years, AAOI was in the second quartile. Currently, AAOI is lower quartile at -84% of EBITDA (-$25.98 million).
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AAOI’s Cash, %Revenue has exhibited a volatile overall uptrend over the period. This improvement was accompanied by an opposite trend for the Applied Optoelectronics Inc Peer Group. (Since 2013 Cash, %Revenue has experienced a sharp decline.) In most years, AAOI was in the second quartile and lower quartile. Currently, AAOI is slightly above median at +22%.

PROFITABILITY

AAOI’s return on equity has eroded very significantly since 2011 accelerating very sharply after the 2017 level.
A major analytical focus for AAOI is a very strong negative trend in pretax operating return a significantly offset by very strong positive trend in non-operating factors.
The productivity of AAOI’s assets declined over the full period 2009-2019: asset turnover has suffered a very strong overall downtrend that accelerated very sharply after the 2017 level.
Reinforcing this trend, pretax margin experienced a very strong overall downtrend that accelerated very sharply from the 2017 level.
Non-operating factors (income taxes and financial leverage) had a very significant positive influence on return on equity.
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AAOI’s return on equity is lower quartile (-4.6%) for the four quarters ended March, 2019.
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Operating performance (pretax return on assets) is lower quartile (-4.9%) reflecting asset turnover that is lower quartile (0.52X) and lower quartile pretax margin (-9.4%).
Tax “keep” rate (income tax management) is lower quartile (61.8%) resulting in after tax return on assets that is lower quartile.
Financial leverage (leverage) is substantially below median (1.52X).

GROWTH RATES

There are no significant differences between Applied Optoelectronics’ longer term growth and growth in recent years.
Applied Optoelectronics’ historical income statement growth and balance sheet growth have diverged. Revenue growth has paralleled asset growth; earnings growth has exceeded equity growth.

Annual revenue growth has been 13.8% per year.

Total asset growth has been 18.6% per year.

Annual E.P.S. growth has been 137.3% per year.

Equity growth has been 22.3% per year.
No consensus growth rate forecast is available for Applied Optoelectronics.
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Relative to the Applied Optoelectronics Inc Peer Group, AAOI’s historical growth measures are generally top quartile. E.P.S. growth (137.3%) has been upper quartile. Total asset growth (18.6%) has been at the upper quartile. Equity growth (22.3%) has been at the upper quartile. Revenue growth (13.8%) has been slightly above median.

Consensus growth forecast is unavailable.
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PRICE HISTORY

Over the full time period, Applied Optoelectronics’ stock price performance has been significantly below market. Between October, 2013 and August, 2019, Applied Optoelectronics’ stock price fell -20%; relative to the market, this was a -51% loss. Significant price moves during the period: 1) May, 2018 – May, 2019: -81%; 2) July, 2017 – March, 2018: -74%; 3) May, 2016 – July, 2017: +824%; 4) January, 2015 – October, 2015: +131%; and 5) March, 2014 – January, 2015: -64%.
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TOTAL INVESTMENT RETURNS

Current annual total return performance of -73.9% is lower quartile relative to the S&P 500 Composite.
In addition to being lower quartile relative to S&P 500 Composite, current annual total return performance through July, 2019 of -73.9% is lower quartile relative to Applied Optoelectronics Inc Peer Group.

Current 5-year total return performance of -11.1% is lower quartile relative to the S&P 500 Composite.
Through July, 2019, with lower quartile current 5-year total return of -11.1% relative to S&P 500 Composite, AAOI’s total return performance is lower quartile relative to Applied Optoelectronics Inc Peer Group.
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VALUATION BENCHMARKS

Relative to S&P 500 Composite, AAOI’s overall valuation is normal. The highest factor, the ratio of enterprise value/assets, is lower quartile. Ratio of enterprise value/revenue is lower quartile. Price/equity ratio is lower quartile. Price/earnings ratio is unavailable. Ratio of enterprise value/earnings before interest and taxes is unavailable.
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AAOI has a very large value gap compared to the median. For AAOI to hit median valuation, its current ratio of enterprise value/revenue would have to rise from the current level of 0.99X to 1.19X. If AAOI’s ratio of enterprise value/revenue were to rise to 1.19X, its stock price would be higher by $3 to $13.
For AAOI to achieve upper quartile valuation relative to the Applied Optoelectronics Inc Peer Group, its current ratio of enterprise value/revenue would have to rise from the current level of 0.99X to 3.41X. If AAOI’s ratio of enterprise value/revenue were to rise to 3.41X, its stock price would increase by $31 from the current level of $10.

VALUE TARGETS

AAOI’s future returns on capital are forecasted to fall short of the cost of capital. Accordingly, the company is expected to be a major Value Eraser.
Applied Optoelectronics’ current Price Target of $19 represents a +85% change from the current price of $10.12.
This high appreciation potential results in an appreciation score of 74 (only 26% of the universe has greater appreciation potential.)
Notwithstanding this high Appreciation Score of 74, the low Power Rating of 6 results in an Value Trend Rating of D.
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Applied Optoelectronics’ current Price Target is $19 (-55% from the 2018 Target of $41 but +85% from the 08/06/19 price of $10.12). This dramatic fall in the Target is the result of a +32% increase in the equity base and a -66% decrease in the price/equity multiple. The forecasted decline in return on equity has a very large negative impact on the price/equity multiple and the forecasted increase in cost of equity has a very slight negative impact as well. Partially offsetting these Drivers, the forecasted increase in growth has a very large positive impact.
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PTR’s return on equity forecast is -1.4% — significantly below our recent forecasts. Forecasted return on equity enjoyed a dramatic, erratic increase between 2011 and 2018. The current forecast is significantly below the 2013 peak of 19%.

PTR’s growth forecast is 19.0% — substantially above our recent forecasts. Forecasted growth suffered a dramatic, erratic decline between 2011 and 2018. The current forecast is significantly above the 2017 low of 2%.

PTR’s cost of equity forecast is 6.9% — in line with recent levels. Forecasted cost of equity suffered a dramatic, erratic increase between 2013 and 2018. The current forecast is steady at the 2017 peak of 8.5%.
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At Applied Optoelectronics’ current price of $10.12, investors are placing a negative value of $-11 on its future investments. This view is not supported by the company’s most recent performance that reflected a growth rate of 7.0% per year, and a return on equity of 11.0% versus a cost of equity of 6.8%.
PTR’s 2020 Price Target of $19 is based on these forecasts and reflects an estimated value of existing assets of $22 and a value of future investments of $-4.

About John Lafferty 54938 Articles
During his career, John has developed valuation and stock rating methodologies, managed institutional portfolios and mutual funds, and provided equity research to institutional investors on thousands of companies. He has been Director of Research at PTR since its inception in 2004.

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