LITE - Lumentum Holdings Stock Is Looking Dim

2023-07-17 11:30:18 ET

Summary

• Lumentum Holdings is expected to face challenges through 2024, with projected sales and earnings declines.
• The company's largest segment, OpComms, is experiencing revenue weakness, with a 3% decline in Q3 2023 and a $58.9 million revenue decline in Industrial and Consumer net revenue.
• Lumentum's balance sheet and profitability metrics also show weaknesses, and the company expects inventory build-up to continue in the current quarter and beyond.

Lumentum Holdings ( LITE ) has a number of negatives that are likely to act as headwinds for the stock through 2024. The company has expected sales and earnings declines for 2024 . Lumentum's earnings expectations were also lowered for 2023 and 2024, which is likely to keep negative pressure on the stock. The profitability metrics and balance sheet also show weaknesses.

Lumentum is displaying the opposite of what I normally like to see with a company and stock. Therefore, I think the stock is likely to underperform until conditions turn around and shift to a more positive outlook. The long term could be bright for Lumentum, but there is more downside risk at this time.

Revenue Weakness

The issue that Lumentum is having is that its largest segment (OpComms) is experiencing revenue weakness. The OpComms (Optical Communications) segment handles products for transporting data across fiber optic cables and comprised 87% of FQ3 2023 revenue . Unfortunately, revenue for the OpComms segment declined about 3% in Q3 2023 over the same quarter in 2022. The Laser segment, which comprises about 13% of total revenue, experienced a sales decline of 5.7% in Q3 2023 over Q3 2022. The decline in the Laser segment was attributed to decreased demand for kilowatt class fiber laser products.

The issue within the OpComms segment is from weaknesses in a few areas. Lumentum explained that the company experienced a $58.9 million revenue decline in Industrial and Consumer net revenue, which was attributed to increased market competition. The company also experienced a $28.3 million decrease in Datacom revenue in Q3. This was attributed to decreased demand associated with inventory management and build-up among its customers and from slowing cloud data center customer capital spending.

Lumentum explained in the Q3 2023 conference call that customers had a build-up of ROADMs inventory (an optical network product). The company expects this build-up of inventory to continue in the current quarter and beyond. Lumentum expects this inventory to take a few quarters to reach equilibrium, where the company will begin shipping to customers again for replenishment.

Revenue and Earnings Downgrades

The dismal outlook for Lumentum in the near future is reflected in the downgrades given to revenue and earnings estimates for 2023 and 2024 . Over the past 6 months, Lumentum's revenue estimates were decreased by 29% for 2023 and 47% for 2024. Revenue for 2023 is expected to decline 25% in 2023 followed by a 30% decline in 2024.

The earnings picture is also not encouraging through 2024. Earnings expectations were decreased 11% for 2023 and 23% for 2024 over the past 6 months. Earnings are expected to increase by nearly 3% in 2023, followed by an expected decline of just under 7% in 2024.

These lowered expectations are likely to keep negative pressure on Lumentum's stock. The company would need a positive turnaround in product demand for revenue and earnings expectations to experience upgrades.

Valuation

One bright spot for Lumentum is its valuation. The company currently trades with a forward PE of 12 and a price to sales of 2. Lumentum's forward PE is slightly below the Communication Equipment Industry's forward PE of 13 . The company's price to sales ratio matches the industry's at 2.

While Lumentum's valuation looks attractive, I don't think this is a buying opportunity for the stock yet. I would need to see a significant turnaround in the company's outlook before changing my thesis for the direction of the stock.

Technical Perspective

Lumentum's stock is currently in a new downtrend on the daily chart. The price recently dropped from an overbought condition and is now in a bearish downward trend. The price formed a bearish head and shoulders pattern. The bearishness is reinforced by the MACD indicator in the middle of the chart as the blue line remains below the red signal line. The purple RSI line at the bottom of the chart is also in bearish territory as it dropped below the 50 mark.

Of course, I don't know for sure where the price will go from here. I could estimate that continued bearish price action could take the stock down to the low $40s, where the stock price has support. Keep in mind that any positive news could reverse the trend. The company reports earnings on August 16. So, that event could provide more insight into how the company and stock may perform going forward.

Balance Sheet/Cash Flow

Lumentum's balance sheet weakened in 2023. Net debt went from zero in 2020 through 2022 to a negative $727 million in 2023. The company's total debt of $2.4 billion exceeds the total cash and investments of $1.7 billion. On the positive side, Lumentum has 3.2x more current assets than current liabilities and about 1.6x more total assets than total liabilities for a total equity of 1.5 billion.

Operating cash flow decreased over the past two years. Operating cash flow fell from $739 million in 2021 to $459 million in 2022 and to $245 million in the trailing 12-month period.

Overall, the balance sheet and cash flow are not in terrible shape. The company just has some weaknesses as a result of slower growth this year. The net debt shouldn't be much of an issue unless the company ran into a sustained period of negative cash flow. Lumentum does have an Altman Z-score of 1.62 . Z-scores of below 1.8 indicate distress, with the company at more risk of bankruptcy. However, if Lumentum's business recovers within a few years, the company should remain stable.

Lumentum's Outlook

From the evidence that I gathered, Lumentum may experience revenue and earnings weakness for the remainder of 2023 and probably in 2024. Lumentum's customer demand needs to stabilize and improve before the company's outlook changes to positive.

Since the valuation is reasonable, I wouldn't consider the stock a sell at this point. However, the stock could still experience some losses depending on how the business performs over the next few quarters. The bias is currently to the downside into 2024 due to lowered earnings guidance. Investors should see how the company reports in the next few quarters and see what they say about future revenue/earnings. I would need to see significant upgrades to revenue and earnings expectations before considering a long position. So, for now, I'll remain neutral on the stock.

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