For smaller companies, losing business from a big customer can be painful. That was the case recently for Lumentum (LITE 1.10%), a maker of optical networking and laser components. In early April, Lumentum reported that a top customer had canceled a large order -- thus sharply reducing sales (and profitability) for at least the next two quarters.
It wasn't Apple, which uses Lumentum's laser components for 3D sensing in the iPhone -- and accounts for 29% of its revenue. Rather, it was Lumentum's other top customer, Ciena (CIEN -2.30%). So what should investors make of this news? Let's take a look.
Breaking down Lumentum's ugly financial update
In a prepared statement, Lumentum CEO Alan Lowe said that the big order cancellation came from "a network equipment manufacturer who represented more than 10 percent of our fiscal second quarter revenue." Network equipment isn't the domain of Apple. That is the specialty of Ciena, which counts 85% of the world's communications service providers -- companies like AT&T, Comcast, and Alphabet -- as customers.
Through the first half of Lumentum's 2023 fiscal year (ended December 2022), Ciena and Apple together represented one-third of Lumentum revenue. So the order cancellation was quite significant for Lumentum. For the third quarter of fiscal 2023 (just ended in March), revenue is now expected to be $380 million to $384 million, a big reduction from the previous outlook of $430 million to $460 million.
Even worse, Lowe said Lumentum is expecting a similar pace of shipments from its top customer (Ciena) in the fourth quarter, the three-month period that will end in June 2023. This all implies that Lumentum's revenue and profits could severely shrink for at least the next two quarters.
For the record, Lumentum had been anticipating an adjusted operating profit margin of 17% to 19% for fiscal 2023's third quarter. The end result is likely going to be lower.
A nasty slump for some component makers
Ciena says it is pulling back on optical components purchases due to "inventory management." In other words, it has too many components in stock for current end-customer demand, so the pain is rippling upstream to component manufacturers like Lumentum.
Some of Lumentum's peers in the semiconductor market have been reporting similar weakness in customer demand. For example, in March communications chip designer Marvell Technology Group said data centers and other enterprise markets were dealing with excess inventory and reducing orders as a result.
Ciena also serves data center operators and telecom companies, so perhaps it's this same area that is hurting Ciena. The market seems to think the hurt is coming just in the data center realm as shares of companies more squarely focused on internet infrastructure (like Broadcom and MaxLinear) didn't budge much following Lumentum's financial update.
But that could change. With economic growth hitting the skids in 2023, more communications companies could resort to "inventory management" to keep their own profit margins afloat this year. It all could add up to some short-term irritability for select stocks in the semiconductor and related equipment industry.
Time to buy the dip?
The good news is that data centers and communications infrastructure is still a long-term secular growth trend. If you're bullish on Lumentum and similar companies, however, I'd exercise patience before buying the dip here -- at least until there's some more clarity on how long an order downturn for its components could last, and how deep the cut will be.
Elsewhere in semiconductors, though, it sounds like the industry slump is beginning to bottom. That's particularly the case in the PC and laptop market, which could benefit stocks like AMD, and smartphones, which would be great news for Qualcomm. If you're looking for top chip stocks, this is where I'm buying right now.
