Alcatel-Lucent (ALU) continued its drift downward after reporting second quarter results. Speculators bet wrongly, ahead of earnings, that the company would both beat consensus and issue a higher forecast. Instead, the firm said it lost $0.15 per share on negative free cash flow. Even Alcatel-Lucent's move in boosting shareholder value through the spinoff of a subsidiary, Alcatel-Lucent Submar Networks ("ASN"), failed to bring any enthusiasm for the company's shares. Investors are left wondering when shares will find a bottom. The stock is in a firm bear trend, after peaking at $4.68 in December, 2013, and closing recently at $3.18.
Progress of transition
Profitability is better realized as Alcatel-Lucent transitions its business mix towards a new generation of products. Legacy products still weigh. Restructuring costs still accounted for US $367.2 million (EUR 275 million) in Q2. The firm cut expenses, lowering SG&A and R&D expenses by 13.9 percent and 5.5 percent (year over year), respectively.
Alcatel-Lucent also faced headwinds in Europe and in North America. Revenue fell in both regions. One bright spot was Asia-Pacific. Revenue rose 25.2% to $890.5 million (EUR 667 million). Much of the turnaround in the firm depends on its success in China. The company won virtualization and SDN deals with China Mobile (NYSE:CHL), but the bulk of gross margin improvements will depend on the LTE rollout. These projects are still weighing negatively on margins.
Alcatel-Lucent has a goal of generating $9 billion in revenue in the core networks unit in 2015. The operating margin goal is 12.5 percent. For the first half of 2014, Alcatel-Lucent's operating margin was 8 percent, which is an improvement from 4.3 percent in 2013. The target is ambitious, since project wins are divided among companies like Nokia (NYSE:NOK), Ericsson (NASDAQ:ERIC), and Cisco Systems (NASDAQ:CSCO).
Alcatel-Lucent said in its conference call that it completed its refinancing, which implies it is comfortable with its balance sheet. Restructuring is progressing. The company acknowledged it is still not repositioned yet with a more diverse customer base. This would imply results are unlikely to beat expectations in the near term. Still, Alcatel-Lucent is ready to focus on innovation. Investors should watch for higher R&D spending first. Higher costs in this area would be short-term negative but long-term positive for the company.
Stock approaching bottom
Despite the bearish trend firmly in place for Alcatel-Lucent's stock, fundamentals are still improving. Gross margin, operating cash flow, and free cash flow are all improving. This was helped by cost reduction. The company had set a goal of cutting costs by $2.54 billion from fiscal years 2013 to 2015. Debt was re-profiled, giving the company flexibility in spending on R&D, staff hiring, and marketing.
Alcatel-Lucent could conceivably deliver cash generation of over $267 million in 2015, with help from revenue of $9.35 billion in the core network business. Q2 was weak enough that it cast doubt the company would meet these targets. However, Q2 is a seasonally weak one. This implies better results for the rest of the year.
Alcatel-Lucent is also confident that it will find success in IP routing, thanks to new products like the Nuage Virtualized Services Platform. In the optical networking arena, the Alcatel-Lucent 1830 Photonic Service Switch and a move towards 200G will be sources of growth.
Alcatel-Lucent looks set to erase all the gains it made from 2013, but that implies a stock price of below $2. Given the company's transition is firmly underway, a drop of this size is unlikely. Alcatel-Lucent looks set to play its turnaround story in 2015, making 2014 a period for investors to accumulate shares.
Disclosure: The author is long ALU. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.