Fabrinet: Datacom, Nvidia Driving Optical Revenue Growth

Last month, we covered the importance of optical interconnects in linking GPUs together in clusters in our thematic deep dive “Optical Interconnects Overview: Strong Growth Expected Ahead.” Optical transceivers address bandwidth, or the speed of data transfer in the data center. As hyperscalers work to expand capacity, it’s expected there will be a surge in optic connections.

Fabrinet provides advanced optical communications components for datacom and telecom end markets, customized optics and glass fabrication, and advanced laser and other electro-mechanical parts. Fabrinet has reported consecutive quarters of strong datacom growth, stemming from one of its flagship customers, Nvidia. Fundamentally, Fabrinet possesses stable margins and strong cash flow generation, as top and bottom line growth is expected to accelerate from the low-teens to the 20% range over the next few years.

Fabrinet is clearly a beneficiary of Nvidia’s surging growth in the AI GPU market, with Nvidia’s contribution nearly tripling from 12.5% to 35.1% over the past twelve months. We’ve covered how Blackwell brings an enormous revenue opportunity for Nvidia and its suppliers, and Fabrinet is expected to be a beneficiary of Nvidia’s upcoming superchip, with long-term growth opportunities for optics in the AI data center and in 800G+ data rates.

Fabrinet reports earnings on Nov 4th.

Revenue Growth Reaccelerated in 2024; 149% Q3 Datacom Growth

After a weak start to fiscal 2024 with low single digit revenue growth, Fabrinet finished its fiscal year with revenue growth reaccelerating in each quarter. Over the long-term, analysts currently estimate revenue growth to accelerate each year through fiscal 2027, as Fabrinet captures tailwinds from growth in optics.

Fabrinet reported 9% YoY growth to $2.88 billion in revenue in fiscal 2024, decelerating from 16.9% YoY growth in fiscal 2023. Much of this decline was weighted in the first half of fiscal 2024, as the broader optics industry suffered from a sharp inventory correction in the telecom industry.

Moving forward, analysts expect Fabrinet’s revenue growth to accelerate again on the back of strong datacom revenue growth, with estimates pointing to an acceleration through fiscal 2027. Fabrinet is currently estimated to report 13.4% growth in FY25 to $3.27 billion in revenue, a 5.4 percentage point acceleration, before rising to 14.1% growth in FY26 and 20.8% growth in FY27.

Here's what CEO Seamus Grady said about the long-term opportunity: “If your time horizon is much longer, I think we're in the very early stages of this. So, you can add or subtract as many various as you like, but I still think we're in the very, very early stages of this. And we're just beginning to see what this explosive growth in AI and the infrastructure that's required to power this network will do and what it will need in terms of optical interconnect.

I think it's because optical is the only way that you can get the speed and the bandwidth that you need to get the signals to move around. You just can't do it with traditional interconnect. So, I think there's a kind of a paradigm shift to optical interconnect becoming kind of almost mainstream. And you have to have optical for this. There's no other way to do it.”

On a quarterly basis, fiscal Q1 2024 was Fabrinet’s weakest quarter, with revenue growth of 4.6% YoY, decelerating 7 percentage points sequentially and 16 percentage points from the year ago quarter. This was both in part due to a quarter that was a week shorter (growth was 8% YoY when normalizing for weeks), as well as telecom revenue declining more than (28%) YoY, offsetting 161% YoY datacom growth.

Telecom headwinds continued to persist through Q2 and Q3, with declines of nearly (29%) YoY and (25%) YoY respectively. Datacom growth of 154% and 149% YoY in both quarters offset the lingering weakness in telecom, aiding revenue growth and pushing growth rates up to 10% YoY by Q3. Revenue growth accelerated nearly 5 percentage points QoQ to 14.9% in Q4, as telecom declines moderated as data center interconnect growth ticked up. Datacom remained strong in Q4, with 800G products leading growth, offset by the wind down of 100G products.

For Q1, Fabrinet expects revenue between $760 million and $780 million, for YoY growth of 12.3% at midpoint, with sequential growth in all product categories. This would represent a 2.6 percentage point deceleration at the midpoint, and a 1.1 percentage point decel at the high range to 13.8% growth. With 800G demand remaining strong, datacom is set to remain a primary driver for quarterly performance moving through 2025.

Surging Datacom Revenue Drives Optical Revenue Growth

Similar to what we discussed last month in our optics overview, Fabrinet’s management sees 800G data center transceivers as its largest growth tailwind, followed by 400 ZR and 400G transceivers as the next largest tailwinds. In just eight quarters, Fabrinet’s quarterly datacom revenue has grown nearly 3.5x, from $92.7 million in Q1 of fiscal 2023 to nearly $315 million in Q4 of fiscal 2024.

Taking a step back, growth visibly accelerated sharply in Q4 of fiscal 2023, or the June 2023 quarter, where datacom revenue surged to a record high at $192.5 million, more than doubling YoY and rising more than 50% QoQ. Management said that the “datacom growth was primarily driven by an 800-gig AI data center transceiver program for one of our customers.”

While not named, it’s likely that the customer being referenced is Nvidia, as this growth coincided with Nvidia’s breakout quarter (the July 2023 quarter) with Hopper driving more than 100% YoY and 88% QoQ revenue growth. Management explained that that AI data transceiver program “is ramping very fast, and has obviously become a meaningful contributor to our revenue and our growth rates and has really helped us to absorb the decline in the telecom business.”

They further clarified that they believe it is “very much in the early days of this [particular] program and this [broader] opportunity, very, very much in the early days. We're really just a couple of quarters into this of what we believe, as we understand, it will be a very long cycle and a very long trend.”

Four quarters later, in fiscal 2024 (June 2024 quarter, most recent reported), Fabrinet reported $314.7 million in datacom revenue, an increase of more than 63% YoY. Datacom now accounts for nearly 42% of total revenue, up from 29% a year ago.

However, Q4 saw the start of revenue deceleration in the segment as Fabrinet laps stronger comps with its ramp cycle. Datacom revenue accelerated extremely rapidly, rising from 4.4% YoY to 161.1% YoY in the span of four quarters, before hovering at ~150% YoY for three quarters in a row. While Fabrinet did not provide an exact guide for datacom revenue in Q1, it’s likely that there will be a slight deceleration sequentially as the company laps its peak growth quarter in Q1 2024.

Nvidia Jumps to 35% of Revenue

Despite passing peak growth, management remains optimistic about datacom’s opportunities, especially with core 800G customer Nvidia, which significantly boosted its purchases and relationship with Fabrinet to meet red-hot GPU demand.

Analysts pressed about the potential impacts of Nvidia’s once-rumored Blackwell delay, and if that would affect Q1’s guide, with Fabrinet CEO Seamus Grady saying that Nvidia “continue[s] to see strong demand for their products. And our understanding is that they will extend and expand production based on current GPUs to meet the demand that's there, and we're happy to continue to support them.”

Nvidia has rapidly become a core customer for Fabrinet through fiscal 2024, with its contribution to revenue nearly tripling from 2023. Nvidia was a non-significant customer through fiscal 2022, contributing anywhere from 0% to 9.99% of revenue, before contributing 12.5% of revenue in fiscal 2023 and now 35.1% in fiscal 2024 (June 2023 to June 2024).

Source: Fabrinet 10-K

In dollar terms, Nvidia’s revenue surged 206% YoY, from approximately $331 million in fiscal 2023 to $1.01 billion in fiscal 2024. Cisco remained Fabrinet’s second-largest customer, contributing 13.4% of revenue (~$386 million) in fiscal 2024, down from 15.6% in fiscal 2023 (~$413 million). Lumentum and Infinera had previously been major customers, accounting for more than 10% of revenue each in fiscal 2022 and 2023, but both fell below the 10% reporting threshold in fiscal 2024.

While Nvidia presents a strong growth opportunity, it’s also a risk, as the significant concentration in Nvidia opens up the door to a large chunk of lost revenue if Fabrinet lost Nvidia as a customer. However, management is working on additional opportunities outside of Nvidia in merchant transceivers and with hyperscalers, noting that they “really don't mind whether it's Ethernet or InfiniBand or anything else” supporting AI infrastructure buildouts, having the flexibility to work across different networking infrastructure.

Additionally, Fabrinet is one of a handful of suppliers to Nvidia, who is now expected to be expanding its supplier base in order to expand its GPU supply. Analysts from B. Riley stated earlier in October that its “latest checks indicate that Nvidia may have added another supplier for 1.6T, which it believes is Eoptolink. As such, Nvidia’s 1.6T allocations will be in question between incumbers Coherent, Innolight, Fabrinet and a newcomer in Eoptolink.”

Margins

Compared to other companies in the optics space that we covered in our prior update, Fabrinet has a much thinner gross margin profile in the 12% range, but stable and strong operating margins and a strong bottom-line.

Fabrinet has maintained its GAAP gross margin above 12% since Q1 of fiscal 2022, with some minor FX-impacted fluctuations. GAAP operating margin has steadily risen since 2020, rising from ~7% to the high 9% range in fiscal 2023 and 2024. Given the thin gross margins, this is a great example of Fabrinet’s operational leverage, to drive a 200 bp+ increase in operating margin on a <100 bp expansion in gross margin.

GAAP net margins reflect the strength of Fabrinet’s operating margin profile, with the company reporting a 10.3% GAAP net margin for fiscal 2024, expanding 70 bp from 9.6% in fiscal 2023. This is what gives Fabrinet a very strong bottom line: GAAP EPS was $8.10 in fiscal 2024, a 20.4% increase from $6.73 in fiscal 2023.

Looking ahead, GAAP earnings are expected to continue growing, with analyst estimates calling for 15.1% YoY growth to $9.32 in EPS in fiscal 2025 and 19.0% growth to $11.09 in fiscal 2026.

Balance Sheet and Cash Flows

Fabrinet also has a robust balance sheet alongside rapidly increasing cash flows.

Cash, equivalents and investments totaled $858.6 million at the end of fiscal 2024, up from $550.5 million at the end of fiscal 2023 due to strong operating cash flow growth.
Fabrinet reported zero debt at the end of fiscal 2024.
Operating cash flow was $83.1 million, or 11% of revenue, in Q4. For fiscal 2024, operating cash flow was $413.1 million, or 14.3% of revenue; this was an increase of nearly 94% YoY from $213.3 million, or 8.1% of revenue, in fiscal 2023.
Free cash flow was $70.4 million, or 9.3% of revenue, in Q4. For fiscal 2024, free cash flow was $365.6 million, or 12.7% of revenue, increasing more than 140% YoY from $152.0 million, or 5.7% of revenue, in fiscal 2023.

Valuation

Despite its strong bottom line, Fabrinet is trading at elevated multiples relative to historic trends. This is important to track as well given the longer duration of both its top line and bottom line acceleration, with growth expected to accelerate to above 20% by FY27.

Fabrinet is trading slightly above 3x sales and 2.7x forward sales, both elevated relative to its prior highs in 2021 at ~2.2x sales and 2x forward sales. Fabrinet has also struggled to maintain multiples above 3x sales – in each of the last four times Fabrinet traded above 3x sales in 2024, it pulled back to below 2.75x to 2.25x within the next six weeks.

On the bottom line, Fabrinet is trading at a ~30x PE ratio and a 24x forward PE, both elevated compared to historical highs. Through much of 2021, Fabrinet failed to sustain a 27x PE ratio, with shares currently more than 10% above that level on a TTM basis. Fabrinet’s 5-year average PE is ~22.7x, with shares briefly trading below that level just once since AI tailwinds from Nvidia became visible in August 2023.

Conclusion

Fabrinet has caught our attention due to Nvidia’s rising revenue contribution, and ahead of Blackwell’s imminent launch this quarter. Fabrinet’s datacom revenue has been strong, and a primary driver of this recent quarterly revenue growth acceleration.

Despite management guiding for a slight sequential deceleration in fiscal Q1, Fabrinet’s revenue growth is expected to accelerate in fiscal 2025 and beyond, as the company captures tailwinds from high-data rate optics and tailwinds from Nvidia. Unlike Coherent, Lumentum, and Marvell that we previously covered in our prior optics overview, Fabrinet has a solid margin profile, a strong bottom line, and exceptional cash flow growth.

This analysis is a preview of what you can expect in our upcoming Discovery tier, which will provide additional analysis on new idea generation stocks that are not currently in the I/O Fund portfolio. We look forward to launching this tier November/December. There will be no changes to our current service tiers, rather I/O Fund Discovery is a service for those who want more new stock ideas beyond what our service currently provides. Stay tuned for more information!

Damien Robbins, Equity Analyst at I/O Fund, contributed to this analysis.

Please note: The I/O Fund conducts research and draws conclusions for the Fund’s positions. We then share that information with our readers. This is not a guarantee of a stock’s performance. Please consult your personal financial advisor before buying any stock in the companies mentioned in this analysis.

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