Luminar Technologies Stock: Seeing No Upside Here (NASDAQ:LAZR)

Great growth ahead, but the road to profitability is tough…

Luminar Technologies, Inc. (NASDAQ:LAZR) is about to begin serial production of its Lidar units. As presented in the recently held 1st Luminar Dayis the company expecting huge revenue growth. Its projections are for 100% compound annual growth over the next 5 years. Their order book has grown well from $1.3 billion in 2020 to $3.4 billion now, and management is aiming to add another $1 billion to it by the end of this year.

However, one must bear in mind that the order book contains estimates of production volumes and price points for Luminar's hardware and software where the customer has not made contractual commitments. Additionally, vehicle development cycles are quite variable and production time delays are not uncommon.

Looking longer, Luminar expects it to be the order book is set to grow to >$5B with 5MM+ vehicles installed with its sensors by 2030. I think these projections are far too optimistic given that the entire automotive industry is projected to produce around 155MM vehicles by 2030. This would mean its sensors are installed in 3, 2% of all vehicles manufactured worldwide; an extremely tall order.

Luminar further projects that it can achieve 35-40% operating margins on a non-GAAP basis by FY2030. This corresponds to GAAP operating margins of 25%-35%. This also seems far too optimistic given the average auto parts industry margins of just over 5% (with R&D expensed). While it's conceivable that production costs will drop radically with automated series production in Mexico and Asia, and its operating costs as a percentage of revenue will drop significantly, I don't see them having such premium margins in the automotive industry (more on this later).

The valuation shows a worthless stock…

As with any young growth company, in order to value Luminar Technologies, Inc., I had to make assumptions about the viability of its business model, its terminal revenues and operating margins. From a market size perspective, the total worldwide automotive market (passenger and commercial vehicles) is expected to grow to approximately 155 MM units by 2030 at a CAGR of 3.7%. I hypothesized that 20% of these new vehicles would be candidates for Advanced Driver Assistance Systems (ADAS) and/or Level 3+ autonomous driving technology. I based this on the recent share of luxury cars being in the range of 15-18% of total vehicle sales. I further assumed that Lidar and competing radar technologies will each take half of this market share and that each vehicle equipped with Lidar would only require one sensor. The Lidar market is already very competitive with various start-ups as well as established Tier 1 vendors entering the field. I think LAZR could take 10% market share but would be forced to drop the price per unit to about $750. Since Luminar would target alternative markets such as aerospace, defense and insurance, I assume these would add another 20% to its revenue. With these assumptions, my estimates yield about $1.4 billion in revenue in FY2030. This translated to ~90% top line growth for the next 4 years, which is just shy of management's 100% expectation.

With serial production in Mexico, Thailand and Asia by 2030, production costs are expected to drop significantly and the company will begin operating profitably. The average R&D-adjusted pre-tax operating margin for auto parts companies is 5.7%, while that for general electronics companies is 10.2%. Because Luminar Technologies is primarily an automotive supplier, Luminar Technologies will ultimately be subject to the same pricing pressure from OEMs as current Tier 1 suppliers, which will limit its operating margins. Being a tech player and offering a somewhat differentiated and highly engineered product, I guess LAZR could get higher pre-tax operating margins of 12.5%. These are more than 2X the average automotive supplier and even higher than a typical electronics company.

Luminar Tech will need to continue to invest in PPE and R&D efforts to achieve this growth. I guess their sales/equity ratio will gradually improve from the current 0.3 to 3 over this period. Note that this is still higher than the industry average of just under 2. I further assume that Luminar could achieve a terminal return on capital of 15%, much higher than their WACC of 10.6% and higher than the industry average of 11.7% .

I think these underlying assumptions are quite generous. With these assumptions, my valuation results in an equity value of $71MM for the company or just ~$0.16/share, making the equity essentially worthless.

FCFF valuation model (million USD)

All potential upside baked in…

Two critical driving forces for the above valuation are the terminal revenues and the terminal's operating margins. Therefore, I tested the impact of these two assumptions on my values ​​using what-if analysis. I ranged revenue from $1.4B to $5.6B (higher than Luminar order book of ~$5B) and operating margin from 8% to 24%. The value of equity was calculated for different combinations of these two variables. The results are presented in the table below with the equity values ​​that exceed the current price highlighted in bold. From the table, one can see that the current price already assumes a minimum revenue of $3.8 billion and a minimum operating margin of 19% by 2030. These are extremely optimistic assumptions and are already baked into the current price. Therefore, I see no upside in Luminar Technologies, Inc. stock.

Risks of technology use and competitive landscape…

I see significant risks facing Luminar Technologies, Inc. – adoption of Lidar technology, OEM pricing, a competitive landscape and potential order book leakage being the primary ones.

Technology adoption – Luminar is dependent on a single technology, which is Lidar. There are alternative competing technologies in ADAS and L3+ autonomous driving spaces. Vision and radar are two such promising technologies. Although each of these 3 technologies has its specific advantages and limitations, it is worth noting that radar is particularly close to Lidar in terms of performance while being a much cheaper and proven technology. The most promising option at this stage seems to be a fusion of different sensors, of which Lidar can be one (in advanced applications). The risk of these alternative technologies replacing the use of Lidar in whole or in part is huge for Luminar.

Competition in Lidar space – Although Lidar is becoming the technology of choice for these applications, the competition in this space has grown significantly. Competition comes from both start-ups and established Tier 1 players developing their own technology or acquiring start-ups. Therefore, there is no guarantee that LAZR's technology will become a dominant force in the market.

OEM pricing for vehicles – The vehicle industry is dominated by large players with enormous pricing vis-à-vis small suppliers. While Luminar may think of its products as premium, it is likely to face pricing pressure, compressing its margins. The automotive industry also demands that its suppliers continuously try to reduce their production costs and pass on a large part of these savings to OEMs in the form of lower prices. OEMs may not want to deal with such small suppliers as LAZR directly. This could force LAZR to be acquired or, at worst, have to sell its product through a Tier 1 sensor integrator, further squeezing Luminar's margins.

The order book may not generate the corresponding revenue – There is a risk that some of the commercial agreements in Luminar's order book may not result in serial production at all. In addition, production volumes may be lower than expected and/or volume production may be squeezed out in the future, lowering revenue forecasts for Luminar.

Play convertible, maybe?

Luminar Tech has a face value of $625MM of outstanding convertible notes, which mature in December 2026. For those who are still bullish on Luminar Tech, this may be a better option than owning shares. These notes come with a coupon rate of 1.25% and a conversion option at a corresponding price of $19.98/share. Currently, these notes are selling for about 65 cents on the dollar, resulting in a very attractive yield to maturity of 13.8%. While this discount calls into question LAZR's viability as a going concern, I believe Luminar could pay off this debt. Luminar typically makes large investments (in acquisitions, large partnerships, etc.) by issuing more equity and currently has $489MM of cash on hand. Although dilutive for equity investors, this strategy allows them to save money. By investing in this convertible debt, you get a healthy YTM while still having the opportunity to capture some of the upside should the share price jump above $20 over the next 3.7 years.

Conclusion

Luminar Technologies, Inc. is competing to become a prominent player in the advanced Lidar sensor hardware and software markets. Careful steps are being taken to drive the automotive ADAS markets in the near term, enabling L3+ autonomy as a long-term venture. However, even with very optimistic revenue growth and operating margin acceleration, LAZR appears to be extremely overpriced at present. Any potential upside in Luminar Technologies, Inc. stock is already reflected in the price and therefore it is better to avoid the stock at this price. Its convertible bonds may offer a better option for those still bullish on the stock.