The optical communications giant Lumentum delivered a truly explosive performance for its second fiscal quarter, not only surpassing expectations across traditional metrics but also providing concrete guidance on a key technological pathway for AI computing infrastructure, securing orders valued in the hundreds of millions of dollars. The company is meeting the expectations of bullish Wall Street analysts, even though its valuation already reflects substantial optimism.
According to Morgan Stanley analysts Meta A. Marshall and Mary B. Lenox in a recent research note, Lumentum's second-quarter non-GAAP gross margin reached 42.5%, exceeding analyst expectations of 38.6% by a significant 385 basis points, primarily driven by product mix optimization and improved pricing for EML lasers. This strong performance propelled earnings per share to $1.67, far surpassing the anticipated $1.38.
More importantly, the company has made substantial progress in the emerging Co-Packaged Optics (CPO) market. Lumentum disclosed it has received an additional purchase order worth hundreds of millions of dollars for scale-out CPO, with shipments expected to commence in the second half of calendar year 2027. Concurrently, the backlog for its Optical Circuit Switching (OCS) business exceeds $400 million, and the milestone of achieving $100 million in quarterly revenue is now anticipated two quarters earlier than initially projected.
Morgan Stanley raised its price target for Lumentum from $350 to $420 but maintained an "Equal-weight" rating. The analysts noted that while the company's fundamentals are robust, the stock price already reflects optimistic expectations for approximately $20 in earnings per share for calendar year 2027, and the current valuation at around 25 times earnings is considered full.
The significantly better-than-expected gross margin was the standout highlight of the quarter. Lumentum reported non-GAAP revenue of $665.5 million and EPS of $1.67, both exceeding Morgan Stanley's estimates of $648.6 million and $1.38, respectively.
The gross margin outperformance stemmed from two key factors. Firstly, an improved product mix, with a greater contribution from higher-margin EML lasers and OCS products. Secondly, the company successfully implemented price increases against a backdrop of persistent supply constraints. Management indicated that despite a 20% capacity addition specifically in the December quarter, supply shortages continue, granting the company significant pricing power.
The non-GAAP operating margin reached 25.2%, also substantially surpassing Morgan Stanley's expectation of 20.6%. The company demonstrated an ability to simultaneously grow revenue and expand margins in a strong demand environment.
Consequently, Morgan Stanley significantly raised its profit forecasts. Third-quarter revenue and EPS estimates were increased from $695.3 million and $1.56 to $804.3 million and $2.24, respectively. Full-year fiscal 2026 revenue and EPS estimates were raised from $2.621 billion and $5.60 to $2.915 billion and $7.63.
If current performance is supported by EML, Lumentum's valuation premium is entirely predicated on its strategic bets for future AI network architecture—OCS and CPO. Information from the report indicates the progress in these two businesses is remarkably rapid.
CPO secures major order: While market discussion on CPO has often been theoretical, Lumentum revealed it has secured an additional "hundreds of millions of dollars" purchase order for scale-out CPO, with shipments expected to begin in the second half of calendar year 2027. This marks a significant milestone for the commercial adoption of CPO.
OCS backlog surges: The ramp-up of the Optical Circuit Switching business is progressing faster than anticipated. The current backlog now exceeds $400 million. More critically, the timeline for reaching a $100 million quarterly revenue run-rate is now expected two quarters ahead of the original plan, signaling an accelerated release of demand for optical switching within AI clusters. The majority of this backlog is anticipated to ship in the first and second quarters of fiscal year 2027.
Despite Lumentum increasing its capacity by 20% specifically in the December quarter, supply shortages persist. This imbalance between supply and demand provides the company with a strong pricing moat.
The 1.6T era favors EML: The company observes that initial demand for 1.6T optical modules is overwhelmingly directed towards EML lasers. This suggests EML will maintain its dominant position in the competition for next-generation high-speed modules.
Robust pricing power: Management explicitly stated that due to broad-based demand for laser chips, components, and subsystems leading to continued supply tightness, the company possesses pricing authority. Morgan Stanley's upward revision to future margin expectations in its model is based on the judgment that these price increases can be effectively passed on to customers.
Based on these strong fundamentals, Morgan Stanley significantly raised its future profit forecasts. Analysts project a staggering 158% compound annual growth rate for Lumentum's earnings from fiscal year 2025 to fiscal year 2027.
Morgan Stanley increased its price target from $350 to $420. This target is derived by applying a 28x price-to-earnings multiple to a calendar year 2027 estimated EPS of $15.
Despite impeccable fundamentals, Morgan Stanley maintained its "Equal-weight" rating. The rationale is that the stock's powerful rebound around the earnings release has already priced in a portion of these optimistic expectations.
The report notes that buy-side expectations are even more aggressive than Morgan Stanley's, with some pricing in a CY27 EPS of approximately $20. At the current stock price, the P/E multiple relative to Morgan Stanley's bull-case CY27 EPS is already approaching 25x.
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