Alcatel-Lucent (ALU) shares got a significant lift around the turn of the year. I believe the stock benefited from capital factors and revived hope for recovery. However, I see ALU losing its capital support over the near-term as those same drivers lose their punch.
Obviously, important operational and financial developments played a fundamental role in Alcatel-Lucent's trading over the last several months. Still, whatever happens around the turn of the year, or within a month of it, can be influenced or exaggerated by capital flows and portfolio shifts. Many such capital changes occur sooner for institutional investors operating under earlier fiscal year ends. For many institutions and all individuals, though, December 31st marks the key date in tax-relative decision making.
Many investors make changes to their portfolios around the turn of the year, dumping their stock losers for tax loss purposes while picking up others' stock losers for the benefit of that same capital driven value creation. It's a factor in the "Santa Claus Rally" and in the "January Effect". Besides ALU's operating issues, we saw selling into August and into October's close, periods within which institutions could be closing their books. Then at the turn of the year, ALU got a sharp lift. But if those capital flows are not followed by fundamental support, such gains can be futile and soon shed.
Another issue that may have helped to lift ALU at the turn of the year may have been the positive news out of Europe that developed through the second half. Europe basically got its all clear signal from the European Central Bank (ECB) decision to give all out support to the euro. From late July and then supported again in September, Mario Draghi finally saw clearly and the European debt crisis was essentially resolved from the perspective of investors. European stocks began to soar, and Alcatel-Lucent is a European stock.
However, we find ourselves now at the Ides of March, and positions old and new are today considering other issues. For instance, Alcatel-Lucent's upcoming earnings report is of concern. In that regard, the analysts' consensus forecast is not foretelling something positive. Based on data found at Yahoo Finance, the average analyst's estimate for the current quarter ending in March has deteriorated to expectations for a loss of $0.11, versus expectations for a $0.08 loss 90 days ago; and the trend has been gradually deteriorating through those 90 days.
Likewise, enthusiasm about Europe has morphed into new concern, with the European Central Bank (ECB) just reducing its expectations for 2013, and with Germany, an important cog in the machine, looking at economic contraction. You can see those new concerns in the six-month chart for the iShares S&P Europe 350 (IEV).
Another chart that illustrates an important trend is the three-month comparison of Alcatel-Lucent , Ericsson (ERIC) and Cisco Systems (CSCO). You can see that ALU has come back to earth in terms of performance, to a point matching ERIC's three-month performance. Is this a function of capital flows? I think so, and also concerns about what real operating performance ALU might produce.
In its last earnings release, ALU showed revenue weakness in Europe and Asia, with support from North America, Brazil and the Middle East and Africa. The most recent gains of ALU and ERIC may be too prospective and a function of bets on value and turnaround. Those may be reined in ahead of earnings or on earnings.
From a valuation perspective, barring renewed solvency concerns, ALU should not have much dollar value down side. Still, what matters to investors is their real return on investment, and the downside potential in that regard could be a mid-teens percentage decline if the stock fell to $1.20. Now, it's got a price-to-book of about 1.3X and it trades at a deep discount to sales, so there is quite a lot of room for improvement on the upside. Of course, the company could solidify itself with a good enough operating result, if it also includes some rock solid evidence of better potential this year. I just do not see that happening yet. I do not see its European market improving, and the situation in Europe is a far cry from its North American developments. The company has disappointed for several sequential quarters around earnings, so I anticipate the investment community will begin to price in that expectation near-term as well, especially considering the estimate trend. Considering the stock also has a beta above 2.0, and with the steam seemingly running thin on this late great rally, I would not put money to work here near-term as I see it at risk.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.