Lumentum Holdings (LITE) is a leading provider of optical and photonic products for a wide range of end-market applications, including optical communications; the stock carries our highest investment recommendation of 5-STARS, or Strong Buy, notes analyst Keith Snyder in CFRA Research's flagship newsletter, The Outlook.
Lumentum also leverages its photonics expertise to produce high-performance commercial lasers for manufacturing, inspection, and life-science applications.
We believe there are a number of trends working in Lumentum's favor, including an exponential rise in data traffic, 5G network deployments worldwide, and the push to incorporate 3D sensing into phones, autonomous vehicles, and virtual reality/augmented reality applications.
We project a 0.8% revenue decline in FY 22 (Jun.) and 10.3% growth in FY 23, following a 3.8% increase in FY 21. Sales in FY 22 will be impacted by a slowdown in global 3D sensing lasers due to certain customer design decisions that will reduce overall demand by approximately 20% to 25%, as well as weak demand for industrial lasers, which has been impacted by Covid-19.
We expect to see a strong recovery in the 3D sensing market in FY 23, supported by growth in the number of mobile devices sold and higher 3D sensing content per device as companies incorporate 3D sensing chips in both front- and rear-facing cameras. The Laser segment should return to growth in the second half of FY 22 as economies reopen and manufacturing capabilities return to normal levels.
Telecommunication demand has remained very strong throughout the pandemic, and we see no reason to believe it will fade for the foreseeable future. Network traffic continues to grow at exponential rates, and operators are investing heavily to keep up with demand.
Sales of its reconfigurable optical add-drop multiplexers (ROADM) are expected to remain strong, supported by 5G deployments and upgrades to existing network infrastructure. While ROADM production has been impacted by component shortages, we believe customers will be willing to wait for orders to be fulfilled, given Lumentum's leading position in the space.
The datacom market will continue to be a bright spot for Lumentum. The company noted that it saw robust growth in electro-absorption modulated lasers (EML), which are used to transmit data and are typically deployed in situations requiring high data rates over a long range.
Lumentum currently has a record backlog in datacom as cloud data centers transition to higher speeds. Growth in this segment has been constrained by manufacturing constraints, but we note its plans to increase datacom chip capacity are progressing well, and management noted that they are increasing capacity over and beyond what had been planned earlier in response to stronger-than-expected demand.
We also see an incredible opportunity for expansion into new markets, especially for its 3D sensing technology. In particular, we view the automotive market as especially appealing given the potential application of its technology for use in autonomous vehicles.
Our 12-month target price of $100 is 17.2x our FY 22 EPS estimate of $5.80. This multiple is a slight premium to peers and its five-year forward average P/E at 16.5x. We believe this multiple is justified by Lumentum's strong long-term growth potential and our expectation that it will weather short-term headwinds.
Risks to our rating and target price include the loss of a large customer, additional component shortages and manufacturing constraints, increased competition, and weaker-than-expected demand in the datacom and telecom spaces.
