ADC Telecommunications Looks Attractive

Aug.14.06 | About: ADC Telecommunications (ADCT)

Investopedia Advisor submits: A stock can get hammered on legitimate problems with its business. However, if its problems are temporary, the stock can be picked up on the cheap, when no one else wants it.

ADC Telecommunications (ADCT) may be a case of the latter. In the spring of this year, the wire line network equipment supplier’s shares traded at $27.90; today they fetch just $13.90.

An unpopular plan to merge with Andrew Corp (ANDW), combined with slashed earnings guidance, has knocked ADC down hard. But by no means is the stock out. There are reasons to think its problems are short-lived.

For starters, ADC’s merger has been scrapped. Investors no longer need to worry about Andrew’s growth and the price ADC was willing to pay for the wireless network specialist. Even so, the stock is still priced 30% less than where it traded before its merger intention was announced.

Of course, nay-sayers point to ADC’s slashed earnings guidance as reason to steer clear of the stock. The company now sees full year earnings from continuing operations of $0.49-$0.57 a share, down from $0.65 to $0.80 per share projected earlier.

The warning comes in the midst of a slowdown in spending on copper and fiber-optic network products from three of ADC’s biggest customers. Both Cingular Wireless and Bellsouth (BLS) have cut spending as they focus on their merger with AT&T (NYSE:T). Verizon (NYSE:VZ), meanwhile, temporarily stopped buying equipment for its fiber-optic network because of excess inventory.

Yet the softer numbers for the next two quarters may well be a short-term glitch. Looking back, ADC has suffered lumpy telecom spending patterns before. Last year, SBC and AT&T pulled their budgets in anticipation of their merger. Shortly after, network spending rebounded. Meanwhile, ADC has also seen gyrations from Verizon’s network build. A similar pattern may emerge through the end of this year and into 2007.

Meanwhile, ADC’s short-term guidance, albeit disappointing, does not speak to the company’s long-term opportunities. ADC supplies telco’s with hardware for fiber-optic network upgrades needed to deliver advanced digital services like video and to compete with cable and satellite TV operators.

Sure, the telcos go through quarterly fluctuations in their buying patterns, but they are committed to the multi-billion dollar task of putting fiber networks into people’s homes -- a long-term trend that will reward ADC.

It’s hard not to think the stock is undervalued. Priced a tad above 2007 revenues, and 12 times 2007 earnings, ADC shares are trading at historic lows, even considering the cuts to this year’s estimates. Meanwhile, ADC continues to show signs of improved operating leverage, as higher revenues push up margins and operating expenses remain under control.

Buying stocks that are out of favor can still be risky. ADC is no exception. As the telecom service market consolidates, ADC gets more vulnerable to the investment whims of fewer telco customers. Given the skittish nature of ADC investors, the stock will no doubt be subject to ups and downs in the coming quarters.

Yet, over the long term, the stock may well prove to be gratifying for patient investors.

ADCT 1-year chart:

By Ben McClure, Contributor - Investopedia Advisor

At the time of release Ben McClure did not own any shares in any of the companies mentioned in this article. Click here to read the Investopedia Advisor's full disclosure policy.