Lumentum's (LITE -1.31%) stock plunged nearly 10% on April 6 after the producer of optical chips and lasers posted its latest earnings report. For the second quarter of fiscal 2023, which ended on Dec. 31, its revenue rose 13% year over year to $506 million but missed analysts' expectations by $1 million. Its adjusted net income dropped 13% to $104 million, or $1.52 per share, but still cleared the consensus forecast by $0.20.

Lumentum's growth rates were lumpy, but its stock had already been cut in half over the past 12 months and trades at just 9 times forward earnings. Should investors take the contrarian view and buy this beaten-down tech stock?

An illustration of a semiconductor.

Image source: Getty Images.

A cyclical stock with customer concentration issues

Lumentum generated 89% of its revenue from its optical communications chips in the second quarter. This segment produces optical chips for service providers, as well as 3D-sensing chips for mobile devices, cars, 3D printers, and other industrial machines. The remaining 11% came from its sales of commercial manufacturing lasers.

Lumentum's largest customers are Apple (NASDAQ: AAPL) and Ciena (NYSE: CIEN), which accounted for 29% and 13% of its revenue, respectively, in fiscal 2022. Lumentum's 3D-sensing chips and lasers power Apple's Face ID features, but TF International Securities analyst Ming Chi-Kuo believes Apple plans to replace Lumentum's lasers with Sony's (NYSE: SONY) in the iPhone 15 Pro. Kuo claims that loss could represent a "long-term structural risk" to Lumentum's business.

Lumentum's dependence on Ciena has also raises red flags. In a statement issued with its second-quarter report, Lumentum CEO Alan Lowe said "a network equipment manufacturer who represented more than 10% of our fiscal second quarter revenue" (most likely Ciena) "would not take the shipments we had originally projected" due to inventory management issues. Those customer concentration issues and the broader macro headwinds caused many investors to shun Lumentum.

Inorganic growth with declining margins

Lumentum's top-line growth accelerated over the past year, but most of that growth came from its acquisition of NeoPhotonics last August. It claimed that acquisition would generate $50 million in synergies over the following two years, but component shortages and the integration of NeoPhotonics' lower-margin optoelectronic products (which are used to transmit optical signals) still reduced its adjusted gross and operating margins over the past year.

Metric

Q2 2022

Q3 2022

Q4 2022

Q1 2023

Q2 2023

Revenue Growth (YOY)

6.7%

(5.7%)

7.7%

13%

13.3%

Adjusted Gross Margin

51%

49.5%

50.4%

48.2%

44.9%

Adjusted Operating Margin

31.7%

26.5%

28.8%

27.1%

23.1%

Data source: Lumentum. YOY = Year-over-year.

Therefore, Lumentum's revenue growth will likely decelerate after it laps its acquisition of NeoPhotonics, while the component shortages and macro headwinds could continue to squeeze its margins.

Its outlook for the third quarter backed that bearish view. It expects its revenue to only rise 9% to 16% year over year, mainly due to its unexpected loss of Ciena's orders, compared to analysts' expectations for 19% growth. And even though it's reining in its spending, it still expects its adjusted operating margin to contract to 17% to 19%.

For the full year, Lumentum expects its revenue to come in at the low end of its prior guidance for 12% to 20% growth as its adjusted EPS declines 10% to 15%. Analysts currently expect its revenue to increase 11% as its adjusted EPS slides 12%. For fiscal 2024, they expect its revenue and adjusted EPS to both grow by about 4%.

There aren't any compelling reasons to buy Lumentum

Lumentum's valuation could limit its downside potential, but its cyclical headwinds, competitive challenges, and customer concentration issues are impossible to overlook. There are also plenty of better diversified tech stocks that are still on sale as the bear market drags on, so I can't recommend buying Lumentum right now.