Alcatel-Lucent Set To Move Higher From Here

Aug. 7.13 | About: Nokia Corporation (NOK)

After many false starts, the turnaround in Alcatel-Lucent (ALU) is taking shape. In the last quarter, the company reduced its debt and operating costs, while positioning itself for the gradual shift to LTE in the United States. As it will illustrated in this article, the positive accomplishments outweigh the negative ones. This suggests the bullish thesis for Alcatel-Lucent (as outlined on June 17, 2013) is still intact. There are four more reasons now to expect shares to hold above $2.

1. Improving margins

Alcatel-Lucent generated gross margin in the 30% level in 2012. Margins should be expected to rise as the company shifts its product mix towards IP routing and platforms over the next three years. A recovery in optics, with Alcatel-Lucent's 1830 platform and 100G line card, and operating expenditure reductions should also contribute to improving profitability.

2. Momentum in China

Alcatel-Lucent expects more than 200,000 LTE active base stations will be launched in China through China Mobile. This will offset weakness currently being experienced in Europe.

3. Voice-over-LTE

Alcatel-Lucent will experience steady growth in hardware network sales when voice-over-LTE is launched in the U.S.

4. Collaboration with Qualcomm

A collaboration with Qualcomm Technologies (NASDAQ:QCOM) to develop small cell base stations for 3G, 4G and WiFi networks will help both companies move more quickly in the multi-technology platform. The next generation of Alcatel-Lucent's lightRadio will use Qualcomm's Small Cell chipsets. Since mobile data traffic is growing rapidly, both companies will benefit from the R&D partnership.

Financial analysis

As mentioned earlier, the positive points outweigh the negative ones. The points below were extrapolated from the second quarter conference call and presentation.

Positives:

  1. 9% Growth in Network
  2. IP Routing grew 26% from previous year
  3. EUR 120 million in cost savings achieved
  4. Operating working capital is healthy, since inventories, receivables, and payables as a percent of revenue is 3%
  5. EUR 4.93 billion in cash and marketable securities
  6. Debt maturing by 2015 will drop from EUR 1.8 billion, to EUR 450 million

Negatives:

  1. Cash flow is still negative, at EUR -248 million free cash flow reported in the second quarter
  2. Submarine business was weak, but could be at a low point in quarter
  3. Goodwill write-down was EUR 634 million, due primarily to impairments and foreign changes

Conclusions

Additional risks remain in holding Alcatel-Lucent, since cash flow could be expected to remain weak. Alcatel-Lucent said that restructuring costs could be as high as EUR 700 million, impacting cash flow negatively. An additional headcount reduction should be expected, although most cuts were done in previous quarters. Despite the worries, Alcatel-Lucent is in a very good position to generate stronger sales from this point forward. In the U.S., Alcatel-Lucent grew its customer base. Voice-to-LTE will also offer additional growth. The current quarter could be the start of sustained growth, and an upward trajectory for the company's businesses would support a higher share price from here.

Disclosure: I am long ALU. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.