Better Buy: Lumentum vs. Finisar

Optical component specialists Lumentum Holdings (NASDAQ: LITE) and Finisar (NASDAQ: FNSR) have enjoyed similar catalysts and business conditions this year. Both companies have seen their revenue decline due to tepid demand for optical component products in China, but the hope of a design win at Apple for 3D sensing chips has given investors in both optimism, though that is now leaning in Lumentum's favor.

LITE data by YCharts

At Finisar, execution issues have reportedly delayed any new-iPhone-related gains.

Therefore, investors have preferred Lumentum since it has promised a major spike in 3D sensing revenue given its $200 million order pipeline, mainly from a single customer. But is this reason good enough to bet on Lumentum instead of Finisar? Let's take a look.

Image Source: Getty Images.

The case for Lumentum

Lumentum has built a sizable revenue pipeline from 3D sensing products and reported just over $1 billion in total revenue in the recently concluded fiscal year. And most of the gains from the 3D sensing opportunity are yet to be realized, as the company generated just $5 million in revenue from these chips last quarter. Therefore, sales of 3D sensing chips to Apple could significantly boost Lumentum's top line.

Furthermore, Lumentum is busy increasing its manufacturing capacity in light of increased demand for 3D sensing chips. Additionally, the chipmaker is trying to improve manufacturing yields.

Last quarter, Lumentum's revenue fell close to 8% from the prior-year period thanks to a decline in optical component sales. More specifically, the chipmaker lost almost $15 million in revenue from this segment in the fourth quarter, which means that its 3D sensing opportunity could be enough to mitigate any weakness here.

Moreover, the optical component business could stabilize on the back of inventory restocking by Chinese telecom companies, helping Lumentum bring its revenue growth back on track as 3D sensing orders start materializing.

Finisar is in a spot of bother

Finisar had drummed up a lot of hype earlier this year when management dropped hints that it was in the running to supply vertical-cavity surface-emitting laser (VCSEL) chips to Apple for enabling 3D sensing applications. This wasn't surprising as Apple was supposed to tap multiple suppliers for 3D sensing chips, and Finisar looked like one of the beneficiaries.

But the company's latest quarterly report revealed that it has run into production issues with the 3D sensing chips, so any shipments to Apple would be delayed by a quarter. Optimists might say that Finisar's iPhone-related gains have been delayed by a quarter. But it could lose a share of the pie if other suppliers shore up their production capacity and get bigger contracts from Apple.

Finisar's guidance doesn't inspire confidence, either, as the rate of decline in its revenue is expected to accelerate in the ongoing quarter. Weakness in optical component demand and uncertainty at Apple seem to have dented management's confidence in the company's ability to deliver top-line growth.

This makes the stock a hard sell to investors as Lumentum seems to be better-placed to make a comeback given its solid 3D sensing pipeline, which is the crucial difference between the two companies.

The verdict

Lumentum clearly looks like the better bet as it has already started benefiting from the iPhone opportunity, which will allow it to cover up for the weak optical component demand. Finisar's prospects, on the other hand, remain clouded with uncertainty. Not surprisingly, Lumentum's earnings-per-share estimates have taken off in recent months, while Finisar's estimates have had a steep drop-off.

This makes it even easier for investors to make a choice between these two optical component suppliers.

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Harsh Chauhan has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Apple. The Motley Fool has a disclosure policy.

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