Electro Optical Engineering Should Ride Bandwith Wave

Electro Optical Engineering provides test and measurement equipment for telecommunication carriers and cable operators to test and monitor fiber optic networks.

Electro Optical Engineering has a market cap of about $483 million, $115 million in cash and no significant long term debt. The trailing P/E is about 38.

Electro Optical reported third quarter 2007 earnings a few days ago. Sales came in at $39.2 million and GAAP net earnings totaled $2.6 million or $0.04 per share. Sales increased 10.7% year over year and 11.4% sequentially from the second quarter. Gross margins were 57.1% compared to 56.4% in the third quarter of 2006 and 57.5% in the second quarter of 2007.

Demand in the optical test and measurement sector remains strong as seen by Electro Optical’s raised forward guidance. The company said it expects “significant growth in the fourth quarter” and raised guidance by about $5 million by forecasting fourth quarter revenues between $41 and $44 million.

Shares of Ciena (CIEN) have been on tear lately as Ciena has raised guidance and beat estimates for two straight quarters. Back in early March Wall Street Mayhem commented that shares of Ciena appeared to be undervalued after the company reported a strong quarter, but the stock dropped. Since then Ciena has turned in another great quarter and this time the street took notice. More importantly, Ciena’s strong results show that demand for the optical sector as a whole is continuing to grow.

JDSU Uniphase (JDSU) has reported mixed results lately. However, JDSU has shown strong demand and growth in optical test and measurement equipment. Strength in test and measurement at JDSU is a good sign for Electro Optical because Electro Optical derives nearly 80% of total company revenues from the optical test and measurement division.

Demand for increased bandwidth is showing no signs of slowing down. Bandwidth intensive applications using video continue to gain consumer adoption. A recent article in the Financial Times suggests that Apple (AAPL) will soon begin renting movies online. Although Apple already sells movies online, the addition of low cost movie rental downloads could have a major effect on the movie rental industry. If downloadable movie rentals from Apple take off like Itunes did, bandwidth usage and demand will skyrocket.

In addition to movie downloads, video applications such as Internet TV should also create a surge in bandwidth demand. The research firm iSuppli recently released a report predicting Internet TV revenues to grow 14 fold by 2011. The report went on to say that bandwidth required for Internet TV will grow by more than 44 times to about seven Tebibytes (TiBs) by 2011.

It seems clear that demand for increased bandwidth will continue to grow for the foreseeable future and shares of Electro Optical Engineering represent a great way to profit from the macro trend in bandwidth demand.

Suggested Trades:

* BUY EXFO near $7.06

EXFO 1-yr. chart:

CIEN 1-yr. chart:

JDSU 1-yr. chart: