Strong Growth Prospects And A Cheap Valuation Make Brocade A Buy

| About: Brocade Communications (BRCD)


Brocade’s financials are improving gradually.

Brocade is generating solid cash flow and has a lucrative buyback plan.

Brocade’s leading position across different areas puts it in a good position for the long run.

The stock is cheap, and decent earnings growth is expected in the future.

Networking infrastructure and solutions provider Brocade Communications (NASDAQ:BRCD) is already up in the teens this year, but the company's performance in the recently reported first quarter wasn't all that great. However, Brocade delivered slight improvement in its performance in the quarter, which means that there could be better times ahead for the company. Let's take a close look at Brocade's recent performance and its long-term prospects.

Solid performance

Brocade achieved revenue of $565 million for in the first quarter, which was a decrease of 4% from last year, but an increase of 1% sequentially, exceeding the company's own expectations. It also reported non-GAAP EPS of $0.24, exceeding analyst expectations. Non-GAAP operating margin was 27.9% in Q1, up 440 basis points from last year.

Finally, in the first quarter, Frontier generated $109 million in operating cash flow and repurchased $144 million of its common stock, executing its plan to return a minimum of 60% of free cash flow to shareholders. In the current quarter, operating cash flow is expected to be higher sequentially due to the timing of variable compensation payments and interest payments on bonds. With improvements being seen in the business, Brocade is gunning for better financial performance going forward on the back of several catalysts.

Strong demand ahead

A healthy demand for SAN (Storage Area Networking) products in the previous quarter indicates recovery in the storage market. Although IP networking revenue was lower from last year, it was within the range of the outlook. Also, strong customer interest and sales activity in Ethernet Fabric depicts healthy growth. Brocade's net Fabric sales were up 61% from last year because both enterprise and search customers implement next generation networks to support their increasingly virtualized data centers.

There's also strong demand for fiber channel in high-growth storage technology markets such as solid state drives, or SSDs. Silver OEMs, as well as other storage vendors, have released SSD-based storage arrays that include fiber channel connectivity. Fiber channel uniquely delivers high bandwidth capability, record data accessibility, and superior reliability which are critical requirements to optimize the use of SSDs. Additionally, the fiber channel delivered superior availability while reducing cabling, complexity, and other management costs compared to fiber channel for Ethernets FCOE.

Brocade has continued to strengthen its ecosystem by collaborating closely with industry associations and vendors within the industry. Its Gen 6 fiber channel is expected to be available in 2016, and this could be another growth driver.

In the IT business, Brocade continues to make progress toward its strategy of being a network provider of choice across data centers. Data center networking is undergoing a technology transition that includes fabrics, SDNs (Software Defined Networks), and NFVs (Network Function Virtualizations). These technologies are playing an increasingly important role in the field of IP networking customers and offer new selling opportunities for Brocade.

There is an increased customer engagement as a result of Brocade's open and differentiated capabilities in SDN and NFV. In addition, NFV and SDN have acquired crucial vendor capabilities at Tier 1 customers, as providers accelerate new technologies that are more cloud-based while reducing capital expenses.

Brocade's leadership in NFV provides it with new roles with prominent customers. In fact, it is currently working with five of the top 10 service providers worldwide on this technology. Brocade is also expanding its technology leadership through a continued focus on SDN and NFV. It is investing to increase its expertise in software networking by expanding its technology team and recruiting top engineering talent. It is believed that these technologies will continuously evolve and Brocade is firmly committed about leading the NFV and SDN market.

Brocade has made great progress in driving efficiency and improved profitability in its business. This will continue to allow it to deploy sources in strategic areas, contributing to its growth and success.

Valuation and conclusion

Brocade trades at a forward P/E of 11.4 as compared to a trailing P/E of 14.7, representing earnings growth. It can be said that the stock is cheap, and it indeed is when compared to the industry average trailing P/E of 20. Moreover, with earnings growth for the next five years expected to be 10% per annum, I think Brocade could be a good investment at a reasonable valuation. Investors should definitely think of buying the stock for the long run, as it is sitting on a lot of opportunities to grow the business and is also trading at a cheap valuation.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.