The multi-step turnaround plans for Alcatel-Lucent (ALU) are playing out as expected. This would suggest that the stock is fairly valued. The stock is stuck in a trading range at around the $4 mark, but first quarter results suggest the company is worth more. Is there any upside for the stock in the short term? There are five things to consider.
1) Profitability around the corner
Investors should expect limited upside, since the company is merely on the cusp of profitability. For Alcatel-Lucent, the story is the same. In the first quarter, adjusted operating income was EUR 96 million, compared to a loss of EUR 15 million. The company's EBIT was effectively positive. Gross margin and a reduction in fixed costs helped the company report better performance.
2) IP Routing Segment improves
Quarterly revenue grew the most for IP Routing:
Source: Alcatel-Lucent 6K
Adjusted for currency fluctuations, revenue grew by 12% (compared to the reported 16 percent increase). Looking ahead, investors should expect growth to continue here, thanks to strong demand in North America and in Japan. Revenue from Asia-Pacific as a whole grew 19 percent last quarter compared to the previous year. Demand for mobile packet solutions is also strong.
3) Carrier spend
Capital expenditure ("CapEx") from carriers will continue to be strong. Alcatel-Lucent won contracts to supply virtualization application solutions for Telefonica (NYSE:TEF). The company is also a leader in providing wireless solutions for AT&T (NYSE:T), Sprint (NYSE:S), and Verizon (NYSE:VZ). With traffic congestion in mobile expected to worsen, Alcatel-Lucent is strongly positioned to benefit from steady CapEx spending from these carriers. On its conference call, Alcatel-Lucent said it expected demand from Sprint to go up. Sprint is eager to invest in its network over the next few quarters.
4) LTE revenue
Alcatel-Lucent is now benefiting from LTE. Revenue from LTE now exceeds that generated from 2G/3G. With the latter technology account for under one-quarter of revenue, LTE rollouts over the next few years will help contribute to profitability for the company.
Higher deployments in China will boost gross margin. Alcatel-Lucent faced component shortages last quarter, which limited sales. Looking ahead, the company will resolve these issues, leading to better growth.
5) 1 billion savings on schedule
Alcatel-Lucent's pledge to cut fixed costs by EUR 1 Billion by 2015 is on track. Last quarter, operating expenses dropped by 12 percent. By reducing SG&A (Selling, General and Administrative Expenses) expenses, it might be inferred that sales staff are more effective in closing deals.
Carriers could cut spending if mobile data demand weakens, or if demand does not grow as fast as expected. Contracts from customers in China could face delays. Chinese customers are considering passive network sharing options. This means the total addressable market ("TAM") would not be as big as first thought.
Equipment suppliers are not immune to weakening economies, and Alcatel-Lucent is no exception. The long-term bullish thesis for the company does not change, but investors should expect negative turbulence in its shares ahead. Instead of fretting on the drops, investors should build a position in the stock. By 2015, Alcatel-Lucent should trade higher than where they are trading at today.
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.