Will Alcatel-Lucent (ALU) shares find traction when the company reports earnings in a couple weeks? I wouldn't bet on it, but neither would I bet against it. At its current value, ALU might be priced just about right for this moment in time. However, for the risk takers among us, the EPS report could offer a catalyst they might find worth attempting to understand and harness. I wouldn't play with fire though, where other ideas exist that might not burn me. This article is intended to study the near-term possibilities in a dynamic time for ALU.
When I authored the article, Alcatel-Lucent has Lost its Mojo, I was referring to its "alpha," or company specific driver of the stock. When the company revised its outlook due to altered external and global macroeconomic circumstances, and then announced it would be taking measures to focus its operations, suddenly the factors that had helped to inflate its shares were pulled out of the story. Until the company can regain direction (read positive EPS momentum), its shares shouldn't experience any outsized gains. In fact, I argued that in the market downturn I saw ahead at that time, the stock should underperform due to its beta coefficient of 2.0. The stock is down 3.6% since the day the article was published, but that's a matter of pennies for ALU. In terms of market capitalization, though, it's still 3.6%. The stock is also down 15.7% from its September high close price of $1.27.
Through the month of October, and then again into the close of December, ALU shares should find pressure against them. That's because they currently offer many investors an opportunity to take tax losses (read more selling pressure). For many institutions with fiscal years closing in October, they may also determine to do some window dressing by getting the downtrodden security off the portfolio statement. Of course, individuals have until the close of the year, and some institutions may close their books at that time as well.
Looking ahead to the third quarter earnings report scheduled for November 2, 2012, there seem to be two significant and perhaps foreseeable possibilities, one negative and one positive:
1 Catching the Falling Knife - Oftentimes when a company first reports trouble, a "second shoe drops" after the fact. I suspect this happens because of corporate management bias and premature executive hope for a quick positive turn of events. However, it can often take time to turn a big ship. Making the hard decisions, including determining when to exit businesses or to alter strategy, is not often done quickly and for good reason. In other words, the company might have misjudged or under-estimated the extent of its troubles, which could result in a poor report and further share price injury. Some are reporting expectations for further cutbacks at telecom providers like Verizon (VZ) and AT&T (T), which could weigh further on the shares of companies like Alcatel-Lucent and Cisco Systems (CSCO). Such escalation of issue could increase the chances of a falling knife at the next EPS report. Also, taking action can disrupt operations in unintended ways, because when over 5,000 employees are being let go, you can expect it to affect morale and the daily routine for a great many employees who remain.
2 Throwing Out the Kitchen Sink - Oftentimes, when compensating for restructuring, companies might find opportunity to manage adjusted earnings toward a favorable figure by including everything and the kitchen sink in the write-downs. In other words, the company could produce a favorable adjusted result, which might lift its shares at the report, no matter what its all-inclusive bottom line shows. When expectations have been so deeply cut, like is the case here, it gets easier to find support for the upside.
These are just a couple of the potential short-term catalysts for the stock, which could move it in either direction. However, I think the long-term outlook continues to miss mojo or alpha. Thus, beyond any news event acting as short-term catalyst, my opinion remains avoid for now. Those investors willing to stick it out, might very well be rewarded over a period of years, but I would rather be on a moving ship then waiting for the fog to clear.
Let's review some of the stats heading into the EPS report. When I authored my article on ALU last month, the analysts' consensus estimate for this year's EPS had been cut from $0.17 to a loss of $0.06, which is where it still stands today based on Yahoo Finance data. Analysts are looking for a loss of a penny for the September quarter and EPS of $0.09 for the December quarter. This is where hopeful expectations tend to find adjustment later on. I always question when companies and/or analysts project a meaningful change quarter to quarter during times when operations are under disruption. You can understand my concern, since the analysts' consensus for the full year 2013 is for just $0.06 (versus $0.09 for Q4 2012).
When a company is in the sort of flux that Alcatel-Lucent finds itself in, its P/E based on near-term EPS estimates can be near useless. The company will more likely be valued by its earnings potential, especially if it could reach it before long. Thus, in this case, if I could get a reliable one, I would look to a 2014 EPS estimate to base a P/E on, and perhaps regress it back by a normal growth rate (say the 10% estimated for ALU long-term - according to Zacks Investment Research) to generate a sensible 2013 number to base value upon. There's also something called discounted cash flow valuation that allows analysts to work around a temporary disruption.
Unfortunately, we don't have easy access to a 2014 EPS estimate for ALU, and nor do we have a DCF valuation model for the company. But, understanding that the 2013 analysts' consensus estimate for $0.06 is not going to be a clean number to base value upon, we can still note that the P/E ratio it would generate today is just 17.8X. That compares with a sector P/E of 12.4X, and given the divergence from normalcy in the 2013 figure, that's not too far off. So the stock seems to appropriately price in the uncertainty of the day. In my opinion, buying or selling it around the EPS event is a needless folly. Therefore, my current opinion is neutral for ALU.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.