Citi: Why did TFC's third-quarter gross margin beat expectations despite a revenue miss?

Was the third-quarter shortfall in revenue or profit?

TFC's revenue in the third quarter of 2026 was 1.923 billion yuan, up 31% year on year and 28% quarter on quarter, but 34% and 24% below Citi's forecast and the Bloomberg consensus, respectively.
Net profit was 879 million yuan, up 55% year on year, 16% below Citi's forecast and 11% above the Bloomberg consensus, reaching the low end of investors' previous expectations of around 900 million yuan.

Third-quarter gross margin was 65.0%, exceeding Citi's forecast and the Bloomberg consensus by 15.0 and 15.4 percentage points, respectively. Citi attributed this to high efficiency and capacity loading for passive components, as well as improved utilization and yields for active components.
Citi believes that although the supply of 200G EML chips improved in the third quarter, there is still a lag between improved supply and the resulting output and revenue recognition. Quarter-end inventory rose from 900 million yuan in the second quarter to 1.27 billion yuan, driven mainly by strategic chip stockpiling.

Citi expects revenue from both passive and active components to improve quarter on quarter in the fourth quarter, driven by new passive-component capacity, improved optical engine chip supply and a gradual increase in CPO component shipments.
In the co-packaged optics (CPO) supply chain, Citi believes TFC's first-mover advantage in fiber array units (FAUs), along with its yields and production efficiency, helps protect its gross margin and supply-chain position.
The bank believes the company's passive components currently face limited exposure to FCC-related risks, but FCC could encompass a broader range as related architectures scale up and mature from 2027 onward; CPO could also partly cannibalize the company's 800G and 1.6T businesses in 2027.

Citi cut its revenue forecasts for 2026, 2027 and 2028 by 22%, 22% and 11%, respectively, and its net profit forecasts by 19%, 19% and 1%, respectively. The cuts reflect slower near-term revenue recognition and a more conservative assumption for the ramp-up of optical engines, partly offset by a higher gross-margin assumption.
The bank maintained its buy rating but cut its target price from 378 yuan to 306 yuan. Its valuation continues to use a multiple of 39.5 times updated forecast earnings per share for 2027, corresponding to the average price-to-earnings ratio over the past three years.