Alcatel-Lucent (ALU) crushed expectations with its most recent earnings report. Investors are now expecting a run-up in shares of the undervalued company along with several upgrades over the next few week. ALU traded higher by 13% on Friday making its year-to-date gain 40%. The company slightly exceeded revenue expectations but blew past earnings guidance of $0.07 by posting $0.25. Despite the stock's gain in 2012, the stock was still priced with low expectations, seeing as it lost 70% of its value in the last 6 months of 2011. But now that the stock is trading at $2.20 with a $5 billion market capitalization investors must decide whether it's time to buy or take profits.
The best way to determine whether or not ALU is presenting value is to fundamentally compare the company with its competitors, or more specifically Cisco (CSCO). Cisco is by far the controlling power of the industry, with a $107 billion valuation. CSCO has traded with a bullish trend over the last 6 months; posting a gain of 45%. The company's trading with record revenue and continues to acquire additional assets and grow larger. Therefore, it's safe to say that CSCO is the preferred stock within the industry, but does is present the most upside?
To effectively and accurately, compare an industry or two companies, it could take several articles, or even a book! However, I would rather focus on pure valuation, rather than speculation on future growth, or sales that are yet to be produced. I will be looking at the current valuation of both CSCO and ALU along with sales and earnings, and then a brief look into both company's balance sheet.
Value ( in billions)
Cisco Alcatel-Lucent Market Cap $107 $5 Enterprise Value $79.44 $5.95
The first two pieces of data are what investors use to determine the size, value, or worth of a company. The market cap is the most well-known or used among investors, and it's the price-per-share of a stock multiplied by the number of shares outstanding. As you can see, CSCO is valued much higher than ALU; more than 21x larger than ALU. This means that investors believe CSCO is worth a much larger valuation based on its fundamentals, and its likelihood for growth.
The enterprise value is a much less talked about measurable of value, but I believe it's more accurate. The enterprise value is a measure of a company's value; it's calculated as the market cap plus debt, minority interest and preferred shares, minus total cash and cash equivalents. This means that enterprise value is determined with debt and cash then gives a better idea of its true value. The only problem is that the market cap is still heavily weighted on the enterprise value of a stock. But as you can see, CSCO's enterprise value is just 74% of its market cap while ALU's enterprise value is 19% greater than its market cap.
It's important to remember that just because a company has a lower enterprise value than its market cap, that doesn't mean it's a bad investment. In fact, there are very few companies with a market capitalization lower than its enterprise value. But as a rule of thumb, I do consider companies with higher enterprise values to be worth watching, because it could mean greater value.
Revenue Last 12 Months
We've already established that CSCO is valued at 21x larger than ALU. But what's interesting is that CSCO only returns slightly more than 2x ALU in annual revenue, which means ALU is only half the size of CSCO in actual market share. ALU is not only one of the cheapest stocks in term of revenue within the industry, but it's one of the cheapest in the entire market. There are very few companies that even come close. To better explain take a look at the chart below . The chart shows competitors within the industry, and the size of its market share by sales. You will notice that not only do most stocks within the industry have less revenue than ALU, but all trade with a much higher market capitalization.
Valuation/Sales (in billions)
As you can see, there is no standard for a normal price-to-sales. However, I think that investors should be able to identify the level of value in shares of ALU, compared to sales. In fact, ALU is 12x cheaper than CSCO according to market capitalization and total revenue; which is incredible considering CSCO only returned twice as much revenue as ALU over the last 12 months.
|Net Income||$6.34 billion||$752 million|
The previous data suggests that ALU is by far the cheapest stock in terms of valuation. However, the company's earnings better explain why the stock may be valued so cheap. The single most talked about measurable is the P/E ratio, which is the earnings divided by its price. Typically, the stocks that trade with higher P/E ratios have higher expectations and are considered higher risk. Stocks with low P/E ratios have low expectations and are considered safe investments because it trades closer to earnings. Of course, there are several factors involved with understanding the psyche of investors, which includes the level of importance we place on a P/E ratio, but to sum it up quickly, I would say a stock's P/E ratio is used to determine the level of interest and risk of a stock.
Alcatel-Lucent returned nearly half the total amount of Cisco's revenue, yet CSCO returned earnings of 8.4x greater than ALU. And since we place such a high level of importance on earnings it could explain why ALU is valued so modest considering its high sales. CSCO trades with a profit margin of nearly 15% while ALU just barely returns a profit with a 3.48% margin. But what's important to remember is how much ALU has improved its margins over the last four years. And as ALU continues to cut costs and license its patents to improve margins it seems logical to imply that margins will continue to rise for Alcatel-Lucent over the next few years.
In the last five years CSCO has performed as a highly profitable industry-leading company, while ALU just recently posted its first year of profitability, during the same period. Therefore, it makes sense that CSCO would have more cash and better leverage, along with better returns on its assets. Both companies trade with a considerably low amount of debt compared to assets. CSCO returns 3x more on its assets per year, which is a measure of management effectiveness. However, ALU just recently became profitable, and now plans to license its patents, therefore, I anticipate better returns on both its assets and equity. Overall, both companies have industry leading balance sheets which should allow for future growth.
The value of ALU is obvious; it's the cheapest in terms of all fundamental measures and is now trading higher. I believe the upside potential for this stock is unprecedented and that its future is now brighter than ever. The stock's lost 85% of its value over the last five years, and with so many problems in Europe, investors have been reluctant to invest in the company. Yet, some would suggest that the company is much better positioned for growth and is trading with better fundamentals than in 2007, when it traded with a $30 billion market cap.
If you look at the fundamentals of both ALU and CSCO you would see that ALU is trading with a much higher level of value. Yet, both companies have optimistic futures: Cisco is transitioning itself to a business technology focus, and is growing in all major regions throughout the globe. Alcatel-Lucent has drastically cut costs, is licensing its 29,000 patents, and is developing its network in some of the most populated but underdeveloped regions of the world. The upside potential of each company is encouraging. But when you look at both companies' growth and their current valuations, CSCO could have a great year and return another 25%. On the other hand, ALU could have a once-in-a-lifetime return of more than 200% (previous 52 week highs) with a future that's more optimistic than ever. ALU's stock has unprecedented value compared to its fundamentals.
Disclosure: I am long CSCO.
Additional disclosure: All fundamental data was obtained from Yahoo! Finance. This piece is intended for educational purposes only and should not be used to make an investment decision. Please consult you financial adviser before making any investment decisions.