Lumentum (LITE): Needham & Company's Top Optical Pick for 2016

Needham & Company analyst, Alex Henderson, published a 2016 outlook for the networking space with many investment ideas but his top pick appeared compelling so rather than a brief overview of all ideas, we dove into Lumentum (NASDAQ LITE). If the analyst is correct, the stock has 36% upside based on improving demand on multiple fronts with a conservative sales multiple albeit a high earnings multiple. Notes follow:

CY16 should be a good year for Optical ramping up into CY17 and CY18 as CY16 should be the beginning of the Metro 100G/200G cycle, which should last through CY2020.. Continuing strong growth in the DCI market will also contribute to growth.

As LITE moves into CY16, the company has roughly 50% of its optical product line in soldout conditions. The Industrial laser business is also likely to accelerate. The most interesting aspect of these supply constraints is that they reflect strong demand across numerous segments of the Optical System end markets, including Long-Haul and DCI with Coherent modulators, Metro with ROADMs, and Access Metro with the T-XFP 10G transceivers.

LITE has always been well positioned in the Metro market. Its product line is heavily skewed to Metro and its new products are well positioned for the trend. That’s good news since Lumentum has stated unequivocally that Metro is taking off. Lumentum noted strong Metro orders out of both the US and Europe.

LITE’s CEO just got back from China and says he is being told to expect strong orders and ramping volumes as the delayed build of the long-haul backbone is set to catch up and as the CY16 build programs commence simultaneously.

LITE is trading at 13x EV/E on CY16 estimates and just 1.1x EV/Sales and the analyst believes that there is upside to revenues, gross margins, operating margins and valuation. He is targeting $30/sh, or 36% upside potential, based on TK EV/E and Tk EV/Sales.

No change to the Buy rating or the $30 PT.

The firm's other top picks in Optical were Fabrinet (NYSE: FN) and Oclaro (NASDAQ: OCLR).

The firm's top pick in networking was Gigamon, Inc. (NYSE: GIMO), with Arista Networks (NYSE: ANET) as the second.

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