Lumentum Seeing Painful Supply Shortages, But Underlying Demand Is Strong

 

This is a Dickensian period for Lumentum (LITE), as strong demand for optical equipment from service providers and data center customers (“the best of times”) is offset by significant supply issues (“the worst of times”) that are having a definite negative impact on the company’s ability to ship to demand. At the same time, while the 3D sensing business has probably found an equilibrium for the time being, there are still robust expectations for future growth here.

I’ve written recently on my bullishness on Ciena (CIEN) and Broadcom (AVGO) given those companies’ exposure to the 400G+ upgrade cycle and ongoing investments in hyperscale data centers, and as an important supplier to equipment companies (Ciena), Lumentum should be looking at least two or three years of double-digit growth, with future 3D sensing growth a driver further down the road. Priced for a double-digit long-term annualized return on cash flow and even more undervalued on a multiples basis, I think Lumentum is worth a look from more aggressive investors.

 

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Lumentum Seeing Painful Supply Shortages, But Underlying Demand Is Strong

ams AG Decimated On Further Apple Shortfalls

It’s been a brutal stretch for companies exposed to 3D sensing, with ams AG (OTCPK:AMSSY) (AMS.S) and IQE (OTC:IQEPY) having a particularly rough year. Recent weakness tied to Apple (AAPL) has hit the sector hard (including Lumentum (LITE) ), and weak volumes, underutilized capacity, and price pressure have all combined to savage ams’s near-term earning prospects and share price.

Sell-side analysts have slashed their price targets for ams by two thirds over the past four months, with one analyst going from a target of CHF 190 to CHF 23.60, and it remains to be seen just how quickly Android adoption of 3D sensing will develop and whether OEMs will favor the structured light technology where ams is strongest. Although the shares do look undervalued even after a sharp revision to expectations, this isn’t a hill I’m particularly eager to die on and investors need to weigh the potential of 3D sensing adoption against the risk that the adoption curve will be long enough that ams’s advantages will be whittled away by lower-priced Asian suppliers.

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ams AG Decimated On Further Apple Shortfalls

Ciena Continuing To Execute Well In A Growing, And Perhaps Changing, Optical Market

Ciena (NASDAQ:CIEN) has done alright since I last wrote about the stock, with the shares up around 8% versus a 10% gain in the S&P 500, a 9% gain in Nokia (NYSE:NOK), and a slight decline in Infinera (NASDAQ:INFN), but this optical player remains a controversial and volatile name. Nobody seems to dispute that Ciena today is a stronger company both financially and competitively than it has been in a long, long time (if not ever), but some analysts and investors are still reluctant to trust that the optical equipment market has really changed and that these good times can last.

I hate "it's different this time" stories because in the vast majority of cases, it really isn't different, and investors go away with singed eyebrows. That said, telco metro deployments seem less lumpy than in past cycles, and the industry has benefited from consolidation. What's more, data center interconnect is a meaningful growth opportunity, and traffic growth seems well-supported by growing use of streaming services and increased fiber-to-the-home deployments.

Given the trends in both telco and non-telco spending, I don't think my long-term revenue forecast of 5% for Ciena is ridiculous or even all that ambitious, though I do have some concerns that the actual "flight path" along that trend line will be choppy. I'm a little more nervous about modeling double-digit FCF margins on a sustained basis, but Ciena management does seem to have the company in better shape. All told, if Cisco can, in fact, deliver 10% long-term FCF growth, a fair value in the mid-$20s is reasonable, and the shares hold some appeal here.

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Ciena Continuing To Execute Well In A Growing, And Perhaps Changing, Optical Market

Seeking Alpha: Finisar At Risk Of Profitless Prosperity

I've written in the past that Finisar (NASDAQ:FNSR) is best looked at as a fleeting engagement for active investors, and the last nine months underline why - the shares have lost about 40% of their value as the company has underwhelmed on revenue growth and found no traction with margins. To that end, revenue estimates for FY2016 are now about 6% to 10% lower than they were back in May and earnings estimates have fallen even farther.

The basic bullish driver for Finisar, increasing data traffic growth and increasing demand for 40G (and, eventually, 100G) equipment in the data center, is still valid but the current environment is challenging. Finisar doesn't have a good record of generating meaningful economic profits and the optical sector badly needs consolidation. What's more, the adoption of silicon photonics remains a significant long-term risk. These shares could still see the low-to-mid $20s on a renewed wave of bullishness on the data center upgrade opportunity, but that valuation is predicated in part on the market once again forgetting that this is a cyclical business with a bad record of full-cycle profitability.

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Finisar At Risk Of Profitless Prosperity

Seeking Alpha: IPG Photonics Still On Top Of A Rising Mountain

I've made no secret of the fact that I like and admire IPG Photonics (NASDAQ:IPGP), and I can't say that the shares haven't rewarded that enthusiasm. Since my first piece for Seeking Alpha on the company, the shares are up more than 60%, trouncing other laser companies like Rofin-Sinar (NASDAQ:RSTI), Coherent (NASDAQ:COHR), and Newport (NASDAQ:NEWP), and beating the NASDAQ by a relatively comfortable margin as well.

When I last wrote about the company, the business was running quite smoothly, but I was concerned about the expectations baked into the valuation. The shares have been more or less flat since then on a "net" basis, but I did suggest that investors could look for dips into the $80s as buying opportunities and investors got two such chances (including a move into the $70s).

Now what? I still like this business, and I think IPG Photonics is poised for a decade of revenue growth that averages out to around 9% to 10% a year coupled with excellent free cash flow margins. I do have some worries about the potential of "peak margin", as well as the possibility that IPG Photonics' growth will make it more susceptible to the vagaries of the machine tool cycles, but no stock comes without risks. The shares do look a little undervalued now, but I'd be tempted to try another "buy the dip" move given the macro uncertainties.

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IPG Photonics Still On Top Of A Rising Mountain