Communication Stocks May All Trade Lower But Aren't All Equal

by: Brian Nichols

The communications equipment industry has underperformed the S&P 500 by more than 600% over the last 6 months. A large reason has been sloppy earnings and falling U.S. network sales as AT&T (NYSE:T) stalled infrastructure payouts during the 4th quarter. Therefore, several of the large network providers are seeing higher costs, less profits, and are now lowering guidance as a result of a fallout in services towards the end of Q4. And although the price action in these stocks is validated with fundamental shortcomings, there are still some that are presenting value and should be trading higher.

During the last three days the communications equipment industry has lost 2% of its value, and will most likely continue the loss after disappointing earnings from some of its larger companies. This loss has come after Ericsson (NASDAQ:ERIC) announced a 66% drop in profits and basically named all of the issues within the industry. This loss will most likely continue as several stocks within the industry are trading lower with Juniper (NYSE:JNPR) posting revenue that fell 6% and gave "uncertain" guidance that relates to the same issues originally discussed within the Ericsson quarterly report. In addition to JNPR's miss, Riverbed Technologies (NASDAQ:RVBD) is trading lower in afterhours, by more than 13%, despite meeting expectations, showing the pessimism surrounding the industry.

The recent loss within the sector is creating what I believe is value. However, weak earnings and low guidance from large companies within the industry combined with disappointing earnings from the two largest U.S. service providers could result in these stocks falling further before trending higher. The communications industry had a bad quarter but is growing at a tremendous rate throughout the globe. There are several underdeveloped regions throughout the globe that are testing and developing 2G, 3G, and 4G LTE networks which should return future growth. Nearly all of the companies within the communications equipment industry are optimistic of its long-term outlook. Even Juniper mentioned its "major new product year" yet admitted the immediate future could be difficult during its quarterly report.

Unfortunately, investors seem much less willing to wait and are more interested in current performance. In my opinion, there are 6 major companies within this industry, and each stock is presenting different levels of value. Therefore, I have listed a few of these companies and will briefly explain the future trend of each stock during the next few months, and beyond.

Cisco Systems (NASDAQ:CSCO) is the largest service provider in the industry and has posted a gain of 22% over the last 6 months. Cisco traded with a 1% loss in after hours Thursday and is trading at just 10.22x future earnings. The large gains in shares of CSCO have been a result of a successful reorganization and its growth in all segments. I think CSCO is fairly valued and that it will sustain value despite the industry's troubles. Cisco simply follows its own trend, and for some reason the stock rarely reacts to the discouraging developments of its competitors. Its the one safe place in this industry and is showing continued revenue growth, an improving balance sheet, and is expected to grow earnings in 2012. I think the long-term potential of this company is exciting as it continues to expand with new tools for small business and large corporations, which will be the driving force to higher gains as a long-term hold.

Qualcomm (NASDAQ:QCOM) trades less volatile than the market but is near the top of its trading range with a P/E ratio of 21.34. The stock has gained 12% during the last three months as a result of strong growth and a diversified array of services. QCOM is one of the better technology stocks in the market with impressive margins, strong growth, and practically no debt. The stock is well positioned for future growth and is trading at just 14.49x future earnings; which means analysts expect this company to continue growing at a high rate. However, the stock has been stuck in its current range for more than a year and can't seem to surpass its $60 resistance. The growth is present for the company's stock to return gains, therefore if it can exceed this level then I anticipate large gains. But I wouldn't be surprised to see it retrace and continue the same pattern between $49 and $59 per share for quite sometime.

Ericsson trades at 9.73x future earnings and has lost 31% of its value over the last 6 months. Analysts expect earnings growth, however its margins have steadily declined during the last year while revenue has been below expectations. The company's already announced that it expects a difficult start to 2012, therefore I am unsure of when the growth will occur. Of the communication equipment stocks I believe that ERIC is the riskiest investment. Yet if minor changes are made to its costs I see no reason why it can't improve margins. The stock is presenting some value but because of its recent performance I think there are other stocks within the industry presenting more value that would be less risky investments.

Juniper has lost 30% of its value over the last six months; and traded with an 8% loss after hours Thursday. The after hours loss is a result of earnings that met expectations but were still lower year-over-year with declining margins. The company's margins have declined each of the last 4 quarters as the company attempts to expand with new products and services. The company's future prospects are encouraging, but not its immediate future. I wouldn't be surprised to see the stock trade lower in the coming weeks, however I think it would make a good investment if it can be purchased around $15.

Alcatel-Lucent (ALU) has the network and infrastructure to become one of the largest network providers in the market, but its margins and a connection to Europe has hurt the stock's performance. The stock has lost 65% of its value over the last 6 months, despite trading higher in 2012. The stock has traded lower the last couple days following the results from ERIC. Yet, I think that ALU is the safest stock within the industry at its current price.

The expectations for this company are very low after it lowered guidance following its Q3 report, which is one reason it has lost so much of its value. The company is slowly improving its margins and is expanding its network in some of the most populated yet underdeveloped regions of the world. This includes partnerships with Chunghwa Telecom (NYSE:CHT) and Telefonica (NYSE:TEF) to upgrade its network and develop its 4G LTE. The stock is trading at just 7x earnings and I believe that because it lowered guidance it may very well post a surprising quarter.

Regardless of its upcoming earnings report, the stock is undervalued and near the bottom of its range. For example, Cisco has a market cap of $106 billion and Alcatel-Lucent's cap is just $4.2 billion, however, ALU has returned approximately half as much revenue as CSCO over the last 12 months. This proves that ALU is much larger than its valuation and if the company can improve its margins and capitalize on global expansion it could return very large gains in a short period of time, making this a great value investment.

Riverbed Technologies (RVBD) was once the hottest stock in the market, or at least one of them. Between January 2009 and March 2011 the stock gained more than 630% as a result of incredible fundamental growth and its progress within the cloud. The year 2010 was really Riverbed's breakout year, as it grew revenue 40% and income by over 500%. However, growth has slowed, margins have tightened, and Riverbed is facing several of the same problems that other communication equipment companies are facing. RVBD is by far the most expensive stock of the ones on this list, and has the highest future ratio compared to its current price. However, the company's technology such as the cloud and its WAN optimization has significant growth potential. Since the stock trades so high above both its revenue and income it has to exceed expectations by large margins and avoid negative publicity just to maintain its current price. And with such negativity surrounding the industry I am not sold on this company or the fact that its the best investment at its current price.

The overall trends of these stocks are so heavily dependent on the industry, almost as though it's one big company. With the exception of Riverbed, each of these stocks are trading lower over the last three days. And with the exception of ERIC each are trading lower in after hours following the disappointing earnings report of JNPR and RVBD. So far the industry has seen disappointing earnings, yet the outlook is strong for CSCO; and QCOM has given no reason to doubt its growth. The immediate downside potential for these stocks are significant, except for ALU which in my opinion is already trading near the bottom of its trend, and is the most undervalued according to fundamentals and expected growth. The point is that these stocks may be similar, and may trade lower as a group, but are each individual companies with different outlooks regarding the future. And if you are patient and capitalize on the perception that the entire industry is weak then you can return some massive gains by picking apart the fundamentally strongest stocks that are the most undervalued.

Disclosure: I am long CSCO, ALU.