- The reaction to strong Q1 figures was muted as management tempered investors’ enthusiasm about cost savings.
- Earnings momentum is not shifting: after years of earnings disappointment, the group is probably guiding conservatively in order to keep surprising on the upside.
- Underlying trends were impressive in Q1 and bode well for coming quarters: revenue growth is resilient, while gross and operating margins are expanding fast.
- Many investors are still reluctant to buy the shares, as 2015 targets are aggressive at first sight and the company has a poor track-record.
- This is a great opportunity as Alcatel-Lucent is likely to reach and even exceed its targets and regain its lost credibility.
Conservative financial communication should not overshadow strong underlying trends
Despite earnings once again above expectations, the reaction to Alcatel-Lucent's (NYSE:ALU) Q1 figures was muted, as management tempered investors' enthusiasm by stating that FY14 cost savings would reach EUR250-300m ($344-413m), below the annualized rate from Q1 (EUR143m/$197m) and below the 2013 level (EUR335m/$461m).
In our view, the company is just trying to get consensus expectations under control in order to continue surprising on the upside in coming quarters. Therefore, we would not pay too much attention to this conservative guidance and would focus on underlying trends which were impressive and bode well for coming quarters.
At the top-line level, Alcatel-Lucent's Q1 performance stood out relative to other European equipment vendors with flat revenues on a like-for-like basis or up 4%, excluding the Managed Services business which the company is gradually exiting (revenues down 51% in the quarter). This suggests an attractive positioning (IP routing was up 16%) and continued market share gains (notably in Wireless, with Alcatel up +2% vs. Nokia (NYSE:NOK) flat and Ericsson (NASDAQ:ERIC) -13%).
In all, we remain confident (see our previous article) that underlying revenue dynamics should remain well-oriented, even if reported figures are likely to remain uninspiring, as Alcatel-Lucent revamps its product portfolio, drops poorly-profitable Managed Services contracts and gets rid of non-core assets.
At the operating profit level, both the gross margin (+410bps to 32.8% vs. consensus around 32%) and cost savings surprised on the upside. Even if Alcatel-Lucent commented that the disposal of the Enterprise business would have a small negative impact on the gross margin and that cost savings would be less significant in coming quarters, we believe that the company is well on track to reach our 10% margin expectation in 2015 (vs. guidance at 8%) as:
1) The gross margin expansion is trending well above our +200bps expectation for FY15 (vs. FY13), even taking into account the -50bps impact from the Enterprise disposal. Comps will get tougher by the end of the year, but we believe that the gross margin could end the year up +150bps.
2) Cost savings are also trending ahead of expectations. We said that there could be some upside on the expected 400bps margin leverage from cost savings, as the group's SG&A/Sales ratio could get close to Ericsson's standards (11%). Alcatel-Lucent's SG&A declined to 12.9% of sales in Q1 from 16.6% one year earlier, leaving significant scope for improvement (2% of sales).
3) We assume that upcoming disposals (Alcatel-Lucent targets EUR1bn/$1.37bn disposals) could improve group margins by 200bps.
We stick to our $6-$8.4 range
Many investors are still reluctant to buy the shares, as 2015 targets are aggressive at first sight and the company has a poor track-record. This is a great opportunity in our view as Alcatel-Lucent is likely to reach and even exceed its targets and regain its lost credibility.
We stick to our $6-8.4 valuation range (for full details, click here).