French telecom company Alcatel-Lucent's (ALU) turnaround is moving on the right track. However, the company's shares are down around 15% so far in 2014, primarily due to its first-quarter earnings report. On the other hand, rival Cisco (NASDAQ:CSCO) has gained around 11% in 2014, and its third-quarter performance exceeded estimates. But, in my opinion, Alcatel is still the stock to choose from the two as Cisco is still seeing a lot of weakness in the emerging markets. Meanwhile, Alcatel is cutting its losses aggressively.
Alcatel: Transforming aggressively
In fact, in the first quarter, Alcatel cut its losses by 80% year over year. Going forward, the company is on track to achieve profitability as it is making a number of solid moves. Alcatel management is repositioning the company to benefit from important trends such as IP, Cloud, and ultra-broadband access to reignite growth.
Alcatel's favorable product mix has led to improved profitability in its business lines. Also, the company is continually managing its cost structure to improve the gross margin. Its focus on IP routing is yielding good results as in the first quarter, this business recorded 16% growth year-over-year on a constant currency basis. This reflects the company's ability to deliver double-digit growth. All regions contributed to the overall strength of the division, with Japan and North America being the main drivers. On the product side, mobile packet cost solutions saw good traction.
Alcatel's core router products are also gaining solid traction as seen in four new wins recorded during the first quarter. Moreover, it is landing customers in the cable sector, which demonstrates Alcatel's progress toward a more diversified customer base.
In addition, the company's Nuage venture, which is targeted at software-defined networks, added two new commercial wins. IP Transport, which aggregates terrestrial optics and submarine, grew at a high single-digit pace in the first quarter, confirming the turnaround in revenue initiated in the second part of 2013. Alcatel's 1830 WDM platform also saw huge success with 26 new wins registered in the quarter.
The product mix in terrestrial optics is moving in the right direction. The 1830 platform currently represents 44% of terrestrial optics products revenue, eight percentage points above last year. The 100G deployments are also going on well and represented 30% of WDM line card shipments in the first quarter, 11 points more than last year. Specifically, subscriber data management posted solid growth, driven by continued voice over LTE deployment.
On the virtualization front, the acceleration of virtualized network functionality should lead to increasing demand for virtualized applications like virtualized IMS. Alcatel has grabbed three new contracts in this segment for cloud bands for NAV environment projects, including a tier one customer such as Telefónica.
High broadband products are also in good demand as they grew at a double digit pace, driven by strength in most regions, especially EMEA and Asia Pacific outside China. Alcatel is focusing on innovation to accelerate its pipeline and enrich its portfolio. It aims to deliver 1 billion Euros in savings and also expand its footprint to unlock growth.
Better than Cisco
After taking a look at these moves, it becomes clear why Alcatel is the better choice over Cisco. Cisco is facing tremendous weakness in the emerging markets. Late last year, Cisco had to cut its long-term growth forecast as it became embroiled in the spying scandal. As a result, its business in the emerging markets took a hit. According to Bloomberg:
"Cisco Systems Inc., the biggest maker of computer-networking equipment, reduced its revenue forecast for the next three to five years amid weaker demand from emerging markets and telecommunications-service providers.
The company expects average sales growth of 3 percent to 6 percent in the coming years, Chief Financial Officer Frank Calderoni said today at a meeting with analysts in New York. That's lower than an earlier projection for sales to rise 5 percent to 7 percent, which the company repeated last month.
Cisco is facing reduced spending by phone companies and corporations, as well as slower economic expansion in Europe, Asia and emerging countries. Industry shifts -- such as stronger demand for inexpensive software tools that perform the functions of advanced networking gear -- are also threatening sales growth."
Cisco bulls would point out the fact that the company did well when it reported its third-quarter results. But then, performance in the emerging markets was still weak. As CEO John Chambers pointed out on the recent conference call:
"The challenges we saw in Brazil down 27% and Russia down 28% are consistent with those we are hearing and seeing from our peers and customers, while China declined 8%, Mexico declined 3% and India declined 1%."
Terrific growth ahead
In comparison, Alcatel is doing well in the emerging markets as we saw above. In addition, Alcatel is a better pick for growth. The company is reducing its losses at a rapid rate. It won't be long before the company turns profitable, and Yahoo! Finance analysts also expect the same. As per analysts, Alcatel's bottom line is expected to improve at a terrific CAGR of 100% for the next five years, which is way better than Cisco as it had recently cut its guidance.
Also, Alcatel trades at a forward P/E ratio of just under 18, which means that it is a solid buy given the expected growth in earnings. As such, investors should consider capitalizing on Alcatel's performance this year and buy it instead of Cisco.
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.