Lumentum Holdings Inc.

Moat: 2/5

Understandability: 3/5

Balance Sheet Health: 4/5

Lumentum Holdings Inc. is a global manufacturer of optical and photonic products, primarily serving the communications, industrial, and other specialty markets with advanced components and solutions.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview

Lumentum is a technology company specializing in optical and photonic products used in various industries, with a significant emphasis on networking and communication solutions. The company is structured around three key business areas:

  1. Cloud & Networking: This segment caters to the communication and networking sectors by providing components and modules for optical transport, switching, and access networks. It includes products such as laser diodes, modulators, and optical amplifiers.
  2. Industrial Tech: This segment focuses on selling high-powered lasers, which are critical for many industrial processes and applications such as: laser cutting, welding, annealing, and micromachining. These solutions are used in various applications that include flat-panel displays, manufacturing, and automotive applications.
  3. Other: This segment provides components primarily for the telecom and datacom markets and other specialty markets
  • Revenue Distribution:

The company’s revenue is largely dominated by the Cloud & Networking segment, which in the most recent fiscal year comprised 75% of total revenue, followed by Industrial tech which was 22%, and the remaining revenue from other.

Revenue is distributed mostly in the Americas Region, which provides nearly 48% of the total revenue, EMEA with nearly 35% and the remaining from Asia.

  • Trends in the Industry: The optical and photonics industry is characterized by continuous technological advancements and shifts. In recent years, the industry is seeing higher interest in data center connectivity and AI which makes the high-speed networking a high priority for cloud providers and large tech companies. The trend toward higher bandwidth and faster communication is driving demand for Lumentum’s high-speed components. At the same time, Industrial lasers are becoming increasingly important for various applications.

  • Margins:

Lumentum’s gross margin hovers between 40% and 50% while net margin varies based on special charges or significant financial changes. The company’s operating margin has averaged 14.5% over the last five years.

  • Competitive Landscape:

The market is heavily competitive, with various companies, some of which have a large market share, which includes competitors like Intel, Broadcom, and Infinera in the optical domain. The industrial market contains several competitors, from various small to big international players. The barriers to entry in this market are extremely high because it requires heavy expertise and large capital expenditures.

  • What makes Lumentum Different: The business is differentiated by having strong proprietary technology and IP for its optical and photonic product range. They offer products that have significant performance advantages over those of their competitors, and can customize them for customers with great efficiency. Management focuses on working closely with its clients to customize solutions for their needs. It has a diversified base of customers, instead of being beholden to only a few.

Financials

  • Recent Results: In the recent quarterly financial report for the period ending September 2022. The company reported a net revenue of $400.4 million. Operating expenses were 163 million while the total net income for the period was $8.9 million. Revenue had dropped by approximately 10% year over year, while the earnings fell severely. The diluted earnings per share were reported as a loss of ($0.12) For the three months ended December 31, 2022, Lumentum saw a slight decrease in net revenue year-over-year and reported revenue of $506.8 million while also generating a loss of ($157.7) million or $(2.35) per diluted share. The decrease was in all operating sectors. In the recent fiscal report ending in July 2023, revenue rose to $1,904.5 million, but the total net loss for the period was $(113.8) million or loss per diluted share of $(1.71) In the recent quarter of September 2023, Lumentum made 350.8 million in revenues, an increase compared to last years quarter, however, they also reported a loss of ($147.8) million dollars.
  • Balance Sheet: Overall, the balance sheet is quite stable, with a reasonable ratio of debt to equity. In the most recent balance sheet for September, total assets stand at $3,997.9 million, while total liabilities stand at $2,392 million with shareholder equity at $1,504 million. Total debt stands at around $1,226 million. The current ratio of the company is at 2.4 which represents healthy short-term solvency, and the debt-to-equity ratio is at around 0.8, which is reasonable.
  • Recent Problems: Lumentum has recently been plagued by overcapacity and lowered demand for its products, which has significantly decreased revenue and earnings for the company. Further supply chain disruptions due to the pandemic has exacerbated the issues and made it difficult to forecast the future performance of the company with any certainty. Management has also noted that pricing pressures are beginning to take effect, which could make future earnings look worse. While management believes the fundamentals for its business remain strong, uncertainty looms large and they believe that recovery will take some time.

Moat Rating: 2 / 5

Lumentum’s moat is rated as 2/5. While the company possesses some competitive advantages, they are not strong enough to give it a more solid moat. The company has some intangible assets in the form of patent-protected technology, which can enable a sustainable competitive advantage. It also has a decent distribution network for its products, but that isn’t exclusive. However, the competitive landscape contains many players and they are not completely vulnerable to competition or technological shifts. Their position in the supply chain of large telecom or industrial companies provides some lock-in, and so for all these reasons, I give the company a 2 out of 5 rating.

  • Legitimate Risks to the Moat and Business:

The main risks faced by the company relate to rapid technological change, heavy competition, and customer concentration. The industry that Lumentum operates in faces intense competition from other large and small players and if a better alternative product is developed then its existing moat can easily be eroded. Further, large companies in this industry tend to quickly adopt new innovative processes, which could hurt lumentums competitive position. The company also faces risks relating to consolidation of large customers, which could lead to higher pricing pressures and lower margins. The heavy reliance on a few key customers makes Lumentum vulnerable if any customer decides to make a change, which gives it substantial buyer power. The high R&D expenses and capital expenditure required to stay at the forefront of the technology is also an important point to keep an eye on for the company’s success. Any downturn in the overall economy can also lead to lower growth or a slow-down in sales for the company. The company needs to be able to handle all these risks in order to keep its long term value.

Business Resilience

The company has a good history of being able to navigate downturns in the business cycle, and a healthy balance sheet, but high competition could severely hurt profitability.

Understandability: 3 / 5

The company has a wide array of products and caters to different industries, but the basic principle of its business is easily understood. However, its financials are not the easiest to understand due to the presence of certain non-operating and non recurring expenses in the quarterly reports. This, coupled with the various different segments it has operations in makes it moderately difficult to understand and appreciate its financial situation. Hence the rating of 3/5 for understandability.

The high amount of technological terminology also adds to complexity.

Balance Sheet Health: 4 / 5

Overall, the balance sheet appears healthy, with a decent debt-to-equity ratio of about 0.8, a current ratio of 2.4, and positive free cash flows. However, the recent history of negative earnings has started to create a dip in retained earnings, and needs to be closely monitored. All in all, I have to give it a rating of 4 out of 5 in terms of balance sheet health.