Coherent's AI Selloff Creates Entry, But Cash Flow Risks Remain

What happened

Despite a recent AI infrastructure selloff, Coherent reported record backlog extending through 2028 and shipped first transceivers using 6-inch indium phosphide, boosting margins. However, the DeepValue report highlights that the stock at $333 already prices in sustained AI optical demand and margin expansion, leaving no margin of safety. While the six-inch InP expansion and NVIDIA partnership provide visibility, cash flow remains weak—operating cash flow was just $10M over nine months due to inventory buildup. The report's base case values the stock at $340, suggesting limited upside from current levels, with downside to $250 if datacenter growth slows. Investors should watch for Q4 results to confirm margin guidance and inventory stabilization before adding aggressively.

Implication

Coherent's AI optical thesis is intact, but the stock's high valuation (P/E 146) leaves little room for execution missteps. The key catalysts are Q4 FY26 earnings (revenue $1.91B-$2.05B, gross margin 39%-41%) and clear proof that six-inch output is converting into cash, not just inventory. If inventories stabilize and datacenter growth sustains 25%+ Y/Y, the stock could grind toward the base case $340, but a slip below $285 would trigger a re-assessment. The NVIDIA partnership and LTA provide downside support, but the non-exclusive nature means competitors can also win share. Until free cash flow improves, the risk/reward is balanced; wait for evidence of working capital discipline before initiating new positions.

Thesis delta

The selloff has improved the risk/reward, but the fundamental concerns about cash flow and valuation remain. The report's 'Wait' rating is appropriate until Q4 results confirm the margin and cash flow trajectory. The article's bullishness is premature without evidence of working capital normalization.