Coherent's Rally Supported by Strong Q3, but Cash Flow Concerns Persist

What happened

Coherent reported Q3 FY2026 revenue up 21% YoY to $1.81B, with non-GAAP gross margin expanding to ~39.6% and EPS surging 55%, driven by AI datacenter demand. Management guided for FY2027 growth exceeding FY2026, supported by a 4x indium phosphide capacity expansion through 2027 and a multi-year strategic agreement with NVIDIA. However, the DeepValue report highlights that operating cash flow for the nine months was only $10M due to inventory buildup and $547M in capex, leaving the company with a 53.3x EV/EBITDA valuation and no margin of safety. The market is pricing in sustained hypergrowth, but the next 3–6 months must show improved cash conversion to validate the narrative. The stock's rally may continue in the near term, but the risk/reward is skewed to the downside unless the company demonstrates durable cash generation.

Implication

The strong Q3 and capacity expansion plans support the AI optics growth thesis, but the stock is priced for perfection at 53x EV/EBITDA with minimal free cash flow. Investors should wait for the FY26 Q4 print to confirm demand durability and operating cash flow recovery, or a pullback toward $300 to improve risk-adjusted returns.

Thesis delta

The Q3 results and management's FY2027 outlook reinforce the top-line growth narrative but do not address the underlying cash conversion issue. The thesis remains in a wait-and-see mode, as the market has already priced in continued hypergrowth. The key change is the increased confidence in demand durability (InP expansion and NVIDIA deal), but the fundamental risk of negative free cash flow persists, keeping the rating at WAIT.