Coherent's Margin Expansion Confirms AI Demand, Yet Valuation Risks Loom Large

What happened

Coherent reported sharp margin expansion in Q1 FY26, with revenue up 17.3% driven by AI optics demand, cost discipline, and divestitures, as highlighted in the recent Zacks article. This aligns with the DeepValue report's emphasis on the company's pivot to datacenter optics, where segment profits grew significantly. However, the stock's 64% rally over the past year has already priced in much of this optimism, trading at rich multiples like 27x EV/EBITDA with net debt/EBITDA of 2.7x. Critical risks from the report, such as potential hyperscaler capex digestion and underutilization of new InP capacity, threaten to reverse margin gains if demand slows. Thus, while the news portrays robust growth, it masks underlying valuation and balance sheet vulnerabilities that lack margin of safety.

Implication

Coherent's Q1 results validate near-term AI-driven growth, supporting its strategic focus and potentially attracting more bullish sentiment. However, with the stock trading at $174 and up 64% over the past year, much of this optimism is already embedded, leaving limited upside without flawless execution. High leverage from $2.98B net debt and a $2.56B preferred overhang amplifies financial risk, making the equity sensitive to any earnings disappointment. Investors should closely monitor upcoming quarters for sustainability in margins and demand signals, as any slowdown could trigger a sharp correction. Given the DeepValue report's POTENTIAL SELL rating, waiting for a pullback to around $130 or clearer signs of deleveraging and sustained profitability is a prudent approach to manage risk.

Thesis delta

The news of margin expansion reinforces the bullish AI optics growth story but does not shift the core investment thesis from the DeepValue report, which remains cautious due to overvaluation and cyclical risks. It highlights execution success but fails to address the lack of margin of safety from high multiples and leverage, keeping the recommendation to sell or trim at current levels unchanged. Investors should view this as confirmation of near-term momentum but not as a reason to ignore the looming downside risks from valuation compression or demand deceleration.