AT&T (T) got crushed with its largest one-day loss since the recession after reporting Q1 earnings on Wednesday. The company's weak earnings were a result of soft revenue caused by disappointing subscriber adds. While these two factors caught the headlines, I am much more concerned with its CAPEX guidance and its impact on telecom equipment makers.
A Look Back at CAPEX and its Impact
Last November, telecom equipment makers Ericsson (ERIC) and Alcatel-Lucent (ALU), among many others, traded higher as AT&T provided a boost to the space. On that day, AT&T announced earnings where it hiked its dividend, but also announced that it would spend $22 billion on CAPEX for each of the next three years.
Just in case you don't know, "CAPEX" is capital expenditures that create future benefits, and it is the bulk of business for the telecom equipment companies that build networks. When AT&T announced that it would spend $22 billion in three years, all companies in the telecom equipment space jumped, as $22 billion is more than the $19-$20 billion that had been spent in previous years.
AT&T is now saying "never mind," as it guided for CAPEX spending in the amount of $20 billion for 2014 and 2015, eliminating a total of $4 billion in spending ($2 billion per year). Basically, this is horrible for telecom equipment stocks; yet surprisingly, those most affected traded higher after this news.
An Industry on the Rise
On Wednesday, the telecom equipment space traded higher following AT&T's CAPEX guidance, and has since discounted the bad news. Instead of responding to industry weak guidance from AT&T, the space decided to respond to earnings from Ericsson as the company beat earnings expectations. For the quarter, the company saw 2% growth and provided upbeat commentary during its conference call. Typically, telecom equipment makers trade in tandem, therefore, it's not surprising that investors saw ERIC's earnings as a positive; but to discount AT&T's cuts is a bit odd.
While Ericsson posted strong earnings, AT&T's largest provider, Alcatel-Lucent, was also discounting the bad news. In part due to Ericsson's earnings, but also after the company sold its Programmable Web Unit. Alcatel's "sell" is by most accounts small, but the company recently raised money and has undergone a massive restructuring program to cut costs. Thus, the market perceived the sale as encouraging, or as a sign that more sales could be on the horizon. Once again, this minor sale overshadowed poor guidance from its largest customer.
Finally, many on Twitter predicted that telecom equipment companies could see weakness on Thursday, a late response to the news. Yet instead, the industry is currently responding to earnings from Infinera Corporation (INFN). Currently, shares of Infinera are trading higher by 25% after the company surpassed expectations by a great margin. Much like Ericsson, the company's guidance was also strong to compliment a solid quarterly beat.
When you look at Infinera as a company, its quarterly beat could be quite meaningless. The company reported sales of just $124.6 million, giving it only a fraction of the industry. While Ericsson is a large company, the future performance of the industry will most likely be closely linked to the fundamental performance of Alcatel-Lucent when it reports earnings on Friday. Alcatel-Lucent has reported sales of $18.70 billion over the last 12 months, and is highly diversified in the industry.
So far, we are seeing a trend: Telecom equipment companies are having strong quarters with upbeat short-term guidance, and the market is discounting long-term performance that could be created from AT&T's guidance. Perhaps AT&T's guidance will have little impact, and these stocks are performing well because other areas of the business are growing. However, I find this suggestion highly unlikely. In my opinion, the timing worked out in the favor of those who are long the space, and somehow AT&T's news flew under the radar. This might bode well throughout this earnings season, although I would stay on the defensive, and wouldn't be surprised to see industrywide loss following the very first poor quarterly performance in the space. In other words, be careful in this volatile industry.