Lumentum Holdings Inc. (LITE, Financial), a manufacturer of leading photonic and optical networking products, gained inadvertent notoriety last November when it dropped its quarterly sales guidance because a “lead customer” had reduced a prior order. Market watchers and most analysts immediately sensed the foreboding for Apple Inc. (AAPL, Financial). Lumentum has been a key supplier for 3-D imaging and sensing products that power the face recognition ID laser sensors in higher-end iPhones.
The company’s 3-D laser sensing business, its most prominent operation, accounted for one-third of its $1.3 billion in sales for the past year. Due to its superior technological edge over competitors, Lumentum has a hammerlock on the market for vertical-cavity-surface-emitting laser arrays. The specialized chip the company manufactures, shoots tens of thousands of laser-emitted dots to create a 3-D map of an iPhone user’s face, which allows them to unlock their phones securely.
Although it has been a major Apple supplier, the company is not wedded to the tech giant's fortunes. Lumentum has said it will take a number of quarters to work through its excess inventory due to Apple’s order reduction. Even though iPhone’s sales are on a downward trajectory, the company anticipates 3-D sensing orders should grow again during the second half of 2019, when smartphone makers usually begin their cycle of manufacturing new models.
The company anticipates this market will expand as lower-end Android phones provide face ID capabilities. Cameras equipped for augmented reality as well as computational photographic applications will additionally enhance growth in this area. According to Barron’s, this market has the potential to quadruple to $2 billion by 2021.
Two additional drivers of growth will benefit the company going forward. Lumentum’s current quarter will be the first full accounting period that includes contributions from its Japanese subsidiary, Oclaro Inc., an optical components maker, that was purchased last December. Lumentum expects the purchase will give it a leg up in the $15 billion optical communications market, where it currently has a mid-single-digit share.
Lumentum recently announced it entered into a long-term strategic supply agreement with Cambridge Industries Group, where it will provide advanced photonic chips for optical transceiver product lines used in the rapidly growing telecom client-side communications network area, the photo-chip-driven cloud datacenter sector as well as planned 5G wireless networks.
The company’s strategic plan entails focusing on highly specialized, differentiated technology, rather than competing with low-margin products. Lumentum hopes to implement this strategy with its most advanced new product, a reconfigurable optical add-drop multiplexer (ROADM), which routes beams of light in complex fiber optic networks. The company’s shipments for its ROADM products increased an astounding 110% to $90 million in its second fiscal quarter, compared to the same period the previous year.
ROADMs are an integral component in high-speed fiber optic communications networks. They represent a major leap in optical networking capabilities and will be in high demand as China continues to lay new submarine fiber optic-based telecommunications cables around strategic areas of the world. Emerging markets present an additional growth opportunity as these economies need additional fiber optic capacity to develop a backbone for the future 5G wireless networks.
Lumentum currently trades at approximately 10.6 times next year’s projected earnings, compared with a five-year average of 15.8. Profitable companies comprising the Russell 2000 small-cap index trade at 16.3 times forward earnings on average. By these measures, and given the company’s standing as a prominent manufacturer of optical laser switching components, the stock is worth perusing for enterprising investors.
The Street’s consensus is Lumentum’s sales will increase 46% to $1.9 billion this year, and $2.2 billion for 2020. Analysts anticipate earnings per share will rise 6.4% to $4.46 and $5.30 for 2020. GuruFocus notes the current operating margin of 9.61% is ranked higher than 75% of the 565 Companies in the Global Communication Equipment industry, where the median margin is 3.4%.
Gurus Ken Fisher (Trades, Portfolio) and Jim Simons increased their positions in the stock in December by 86% and 309%.
As a notable Apple supplier, Lumentum may have been the object of some investors’ mistaken impression that its fortunes were joined at the hip with those of one of its large customer. However, as noted above, the company has a number of business operations where its continued strength in laser optical imaging and laser chip technology will position it well for future growth, regardless of the fortunes of Apple.
Disclosure: I have no positions in any of the securities referenced in this article.
