7 Network Companies To Consider For Your Portfolio

by: Richard Saintvilus

There is no doubt that every company strives to grow. And in pursuit of that growth, network enterprises tend to scale larger as well as require increased bandwidth to support the demand for higher traffic. The one sector that is prepared to handle the increased stress on corporate backbones is the networking group. Some of the names will begin to see increased orders for their equipment as well as services throughout the rest of the year.

Investors should consider looking closely at some of the following names as they still present some tremendous value. After all, they are the ones that provide the backbone that manages enterprise data traffic - essentially the blood vessels of the operation. But one thing investors have to realize when making investment decisions is that not all networking firms are the same.

Alcatel-Lucent (ALU)

It appears that there is modest recovery in communications spending for this reason. Things are starting to look more favorable for two the sectors recent underperformers in Alcatel-Lucent and Ciena (NASDAQ:CIEN). Although it is hard to tell of late, the IP and optics businesses for both companies are looking better as well - particularly for ALU. The company's newest routing platform competes extremely well when compared to similar models from Cisco (NASDAQ:CSCO) as well as Juniper (NYSE:JNPR). Some experts have suggested that it might, in fact, be slightly better.

The company is also seeing an uptick in its wireless segment business, and ALU desperately needs this trend to continue. The company has shown that it is not restricted solely to U.S. business as it has managed to get contracts from the three major Chinese service providers in China Mobile, China Telecom and China Unicom. This is even though competitors Huawei and ZTE are prominent and local. This is nothing short of remarkable.

These are not small deals either, and ALU's partnership with China Mobile for a next-generation network could pay large dividends in the years to come. In the U.S. the company has forged deals with the major carriers such as AT&T (NYSE:T) and Verizon (NYSE:VZ) and they continue to spend large sums of money to upgrade and expand networks. As great as that is, I am intrigued to find out how much margin ALU can draw from this business.

Cisco (CSCO)

For quite some time now, Cisco has been considered the gold standard among that group. However there is reason to suspect that the competition for that title is no longer a foregone conclusion. However, I am inclined to look at the entire sector to start to appreciate a little bit more of what each company has to offer in their own right.

In its most recent quarter which ended January 28, Cisco reported net income that climbed 44% and arrived at $2.2 billion, or 40 cents per share. This compares with earnings of $1.5 billion, or 27 cents per share year-over-year. If you factor out that the costs associated with stock-based compensation as well as some acquisition-related amortization, the company actually earned 47 cents per share - 4 cents per share above analysts' expectations based on polls by FactSet. Revenue was $11.5 billion, up 11% from $10.4 billion a year ago and compares favorably to the $11.2 that was projected.

I think that is what analysts continue to ask. As impressed as I am with the report, there continues to be many who are simply unwilling to give the company much (if any) applause for what continues to be a remarkable turnaround from the depths of last summer where Cisco showed little focus whatsoever. Its results clearly demonstrate the company is keen in improving its margins as it reported gross margin that improved a full point from the previous year while also exceeding analyst estimates. However it seems that area of performance is not growing at a rate that appeals to the most ardent bears - at least to the extent where it can prove that it can reclaim some of the market share that it has lost to the competition over the years.

Brocade (BRCD)

Brocade is another interesting story and one that I have recently become enamored with. In its recent Q4 earnings announcement, not only did it beat its projected numbers but it also raised guidance. The question is, though, what did it prove? But that is not to take away from the many accomplishments that it has logged this year, especially considering the market's early reaction to its once perceived inability to compete.

Looking at it from a bearish lens, Brocade's Q4 numbers were far from stellar. The company reported flat revenue on a year-over-year basis and less than 10% sequential. Revenue for its network storage service was down 4% from the previous year, but this was offset with an 11% growth from smaller areas of its business - notably IP. But regardless of how one looks at it, it can't be discounted that it did beat consensus estimates on both year-over-year declines and its end of range. To top it off, profitability was a huge plus.

In 2008, the company acquired one of its competitors, Foundry Networks. That was an acquisition that seems to now be paying off. In the deal, management sought to broaden the company a little bit more and place less dependency on its storage business. The other advantage was it wanted to be able to sell networking gear to its existing customer base to provide the services of a one-stop shop, a strategy that is now proven to have worked or at the very least, currently working. Brocade continues to prove that it can do just fine with a small piece of the market pie for now, but there is no denying that it is hungry for a bigger slice.

Ciena (CIEN)

Optical networking firm Ciena is one company that I've had my eye on for quite some time, and I think that it may be time that other investors do the same. Though its name is seldom mentioned among the ranks of Cisco and HP (NYSE:HPQ), the company deserves a considerable amount of credit for (if nothing else) the fact that it still exists today. While some consider Ciena a product of the tech bubble, the company did not actually enter any legitimate discussion until the bubble had already burst. In similar fashion, the end of the bubble sent many of its clients out of business as many of them over-spent on networking equipment.

So this is where the company still ranks today - at the bottom of the list when it comes to the top networking names in the sector. But it does appear to now have a few things working in its favor. Its recent quarterly performances suggest that management has figured out ways to squeeze more margins out of its products. But analysts continue to question whether or not its recent performance is sustainable.

For this reason, I continue to have my own doubts about the company, and I'm not yet ready to proclaim that it is a buy just yet. What remains to be seen is whether the company has the ability to produce a second act of profitability and growth. It would need to demonstrate this over a period of at least three consecutive quarters for me to feel comfortable that it can run its business effectively. But as prudent as that may be, by then everyone may have figured it out. It's a double-edged sword where risk is the means of profitability. But investors may want to consider some of the names above in anticipation for when technology spending fully returns.

F5 Networks (FFIV)

F5 is one company that always seems to have its act together. The stock is by far the most expensive among the group from a valuation standpoint as well as by virtue of its P/E ratio. There are high growth expectations placed on this company, but remarkably it has yet to give investors a reason to doubt that they can be reached.

The company recently reported fiscal first quarter earnings and both its results as well as guidance were in the range that made analysts happy. The company reported a 2% increase in revenue from the prior quarter while netting an increase of 20% from the previous year. Product revenue was somewhat of a minor disappointment, while software revenue climbed 7%.

Clearly management knows what it is doing, investors are happy and analysts are ecstatic. So what is the problem? Well for starters and as mentioned above, the stock continues to be a tough one to figure out. What is its true value and what makes the company worthy of such an enormous P/E? As well as the company is performing and has been performing, it is hard to recommend the stock at these levels.

Hewlett-Packard (HPQ)

On Wednesday, the company reported net income of $1.47 billion, or 73 cents per share, in the three months that ended January 31. This didn't compare too well with its net income of $2.6 billion or $1.17 per share in the year ago period. Adjusted for one-time items, the company earned 92 cents per share, above the 87 cents expected by analysts surveyed by FactSet. Revenue was $30 billion, down from $32.3 billion and slightly below expectations of $30.7 billion.

The revenue drop was even steeper, 8%, when taking out the effect of changes in currency exchange rates. It was the fastest revenue decline for the company since the recession hit 2009 results. As with Dell and Microsoft (NASDAQ:MSFT), HP blamed flooding in Thailand for more than half of its revenue drop. The floods last year disrupted manufacturing of storage drives, a key component in PCs. HP said it decided to divert resources to higher-margin products, but it didn't do as well as it expected due to ongoing operational problems.

I continue to remain bullish on the company, and think that there is yet 20% upside to be had for value investors. The company is taking a new strategic direction - one that I think makes perfect sense. But investors must not make the mistake of expecting an immediate turnaround. This is going to take some time to realize. As bad as things once looked for this company with its indecision regarding its PCs and tablet initiatives, investors should be comfortable in its new leadership yet appreciate that the old HP might be coming back.

Juniper (JNPR)

For Juniper, the important question continues to surround the overall health of its business. It is interesting when you consider that previously, the debate has always been which of the two is better when compared to Cisco . Now analysts are asking if it can run its business effectively. In January, the company announced that fourth quarter results were going to fall short of Wall Street expectations.

The company guided revenue down to $1.11 billion and 26 cents per share instead of the $1.19 billion and 34 cents that analysts had been expecting. The unfortunate thing for Juniper was that this was to log the third consecutive quarter of shareholder disappointment. The company added that weak U.S. demand and unexpected slow growth contributed to the decline in sales, while at the same time suggesting that it had a "record year" in 2011.

The good thing is that by pre-announcing the softer numbers, the company did accomplish its goals of making a soft landing when the actual numbers were released. As it warned, net revenue for the fourth quarter of 2011 decreased 6% on a year-over-year basis, and increased 1% sequentially, to $1,120.8 million. For the year ended December 31, 2011, its revenue increased 9% on a year-over-year basis to $4,448.7 million while posting a GAAP net income of $96.2 million, or $0.18 per diluted share. All in all, the numbers were decent, not the disaster that they were projected to be. But it begs the question, does management truly have a grasp on the company if it has missed for three straight quarters?

There is cause for optimism, however. The company has an array of new products coming out as it continues to position itself to steal share from the rest of the group. One of these products is called the EX6200 and according to the current reviews, it has the potential to be a game-changer for the company by bringing together various intelligent features into one. As great as that product can potentially be, Juniper's challenge will continue to be finding ways to grow and creating the sort of momentum needed by tech companies to inspire investors to believe. I suppose it really has three challenges.

Disclosure: I am long CSCO, MSFT.