Here’s Why Applied Optoelectronics Inc (AAOI) Shares Are Taking a 7% Nosedive

Rosenblatt's Jun Zhang has approached AAOI stock from the bearish camp, negative on rising "price war headwinds."

Applied Optoelectronics (NASDAQ:AAOI) investors got hit with a new negative note today after Rosenblatt analyst Jun Zhang took a step up to bat- for the bears. Shares were sent plunging 7% on the heels of Zhang’s report. The analyst warns that though this fiber optic specialist eyes potential for hyperscale market gains, he advises to watch out for pressured margins. AAOI gross margins are likely to be put under hot water with pricing rivalry intensifying, with these “wars” having odds to keep casting gross margins down through the remainder of this year and into next year.

As such, the analyst initiates a Sell rating on AAOI stock with a $30 price target, which implies a 29% downside from current levels. (To watch Zhang’s track record, click here)

“We believe demand in both the Chinese and U.S. hyperscale markets will continue to grow over the next two years but expect increasing price competition in the 100G and 400G module markets. AAOI should benefit from increased volume growth, but we have concerns that 40% gross margins are unrealistic going forward. Pricing competition will most likely depress gross margins, and we do not believe this is reflected in current consensus EPS numbers,” writes Zhang, who projects $1.95 in the tech player’s EPS power for next year.

Additionally, the analyst believes probability is favorable for the company’s CWDM4 100G module shipments to Facebook and Microsoft to keep firing up in the third quarter as well as the fourth quarter. That said, “Despite this ramp, we are more concerned with the pricing environment, as both Intel […] and Chinese competitors are getting more aggressive with price,” adds the analyst, who forecasts the fiber optic specialist could merely lessen expenses by 3% to 4% from a better chip on board yield rate.

Should AAOI choose to “internally” manufacture its AWG and PD arrays, the analyst wagers costs could be chopped by a further 3% to 4%. Zhang believes, “Although these cost cuts may benefit AAOI, a potential price cut of over 15% over the next two quarters will pressure their current margin profile. As more Chinese suppliers start producing CWDM4 100G (2KM) modules, we believe the price for these modules will trend towards the $150-$160 range in 2019.”

Moreover, the new bear bets the CWDM4 100G module arena could bear the brunt of fiercer rivalry ahead, with not just Intel in the picture, but likewise from Chinese vendors including the likes of Hisense Broadband. Based on Zhang’s analysis, the analyst anticipates Intel scaled back its CWDM4 100G (2KM) module price tag to $210 in the third quarter and $180 in the fourth quarter. Intel could still face a “challenge” from Hisense Broadband should the Chinese tech player choose to “aggressively” reduce its price for the module to $160 by the close of the year. With a slew of firms prospectively lowering prices for the CWDM4 100G (2KM) module, Zhang surmises the price of these modules will dip under $200 by the close of the year.

TipRanks exhibits a mixed bag of sentiment when it comes to Wall Street’s take on the fiber optic specialist. Out of 3 analysts polled in the last 3 months, 2 are bullish on AAOI stock while 1 is bearish. With a loss potential of 5%, the stock’s consensus target price stands at $40.00.

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