NEW YORK (TheStreet) -- Shares of optical networking giant Ciena (CIEN) have been under pressure over the past six months. Since the stock hit a 2014 high of $25.38 in March, investors have seen more than 23% of their wealth disappear. But things are about to change.
The stock trades around $19.50. Ciena has ways to go to make up the 19% it has lost on the year to date, which trails the tech sector's 11% gain, according to Morningstar. So why is now the best time to buy a stock that has gotten beaten up for most of the year?
Goldman Sachs analyst Kent Schofield believes the selling is overdone. Schofiled recently raised his rating on the stock to buy from neutral and slapped a $26 price target on the shares, which represents a premium of more than 34% from Wednesday's closing price.
Schofield's confidence is a bit surprising to most, especially since Ciena just released downbeat guidance for the current quarter, which sent the stock plummeting more than 7% last Friday.
Still, Schofield believes this quarter's slowdown will be "temporary in nature." Much of this optimism has to do with the recent uptick in Ciena's gross margins, which was a surprise since the company suffered margin compression in both the second and third quarters.
It's also worth noting that despite the downbeat guidance, Ciena did, in fact, post solid results, beating on both the top and bottom lines. That margins were able to expand suggests customers are willing to pay more, even amid weak spending periods. This shows that despite the threats that exist from Cisco (CSCO) and Juniper (JNPR) Ciena is not susceptible pricing pressure -- even from cheaper alternatives.
What's more, Ciena shares, which are trading at just 16 times next year's estimates, are cheap. Ciena is projected to earn $1.21 per share, according to Yahoo! Finance. Following a 12% jump in revenue and an upside surprise in gross margin, Ciena is well positioned to exceed its earnings projections, especially since analysts now expect carrier spending to rebound.
So while Wall Street is modeling for lowered expectations, Ciena's operational improvements, which contributed to the margin growth, will help offset near-term headwinds.
Ciena's main customers included carriers Verizon (VZ) and AT&T (T) . These companies have not spent as much on infrastructure builds as some industry experts predicted. What they have spent hasn't been enough to offset weakness in the other parts of the world. This is the same issue that has impacted Cisco and others that rely on carrier expenditures.
Unlike, say, Juniper, which has more than two-thirds of its revenue tied to carriers, Ciena's converged packet optical division continues to grow at an impressive rate. That business now accounts for more than 60% of the company's total revenue. This shows the extent of Ciena's diversification.
Meanwhile, the company's specialty in broadband, data networking and optical equipment services show no signs of slowing down. This supports Schofield's confidence and his upgraded price target.
The way I see it, if and when carriers finally do open up their wallets, Ciena remains well-positioned to capitalize on that spending. With shares down almost 20% for the year to date, Ciena has all of the makings of a strong turnaround candidate for the second half of 2014 and heading into 2015. An improved spending environment in the second half supports fair value of $22 per share.
At the time of publication, the author held no positions in any of the stocks mentioned, although positions may change at any time.
This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.
TheStreet Ratings team rates CIENA CORP as a Hold with a ratings score of C-. TheStreet Ratings Team has this to say about their recommendation:
"We rate CIENA CORP (CIEN) a HOLD. The primary factors that have impacted our rating are mixed ? some indicating strength, some showing weaknesses, with little evidence to justify the expectation of either a positive or negative performance for this stock relative to most other stocks. The company's strengths can be seen in multiple areas, such as its revenue growth, impressive record of earnings per share growth and compelling growth in net income. However, as a counter to these strengths, we find that the stock has had a generally disappointing performance in the past year." You can view the full analysis from the report here: CIEN Ratings Report