By Fani Kelesidou
Formed in 2006, Alcatel-Lucent (NYSE:ALU) serves as a global provider of telecommunications technologies. Through the ownership of over 25 subsidiaries, ALU operates in more than 130 countries and employs about 76,000 people. ALU offers a diverse portfolio of about 29,000 active patents, including IP, optics, core networks, wireless solutions, and radio frequency systems. The company spends about 16 percent of its annual revenue on its core Research & Development facility, Bell-Labs. The market is treating Alcatel-Lucent as if it were a step away from declaring bankruptcy. With a market cap of $2.40 billion, the stock is priced roughly over $1. So, what is wrong with ALU after all?
Overall, revenue figures for the past couple of years have been flat, showing no impressive upside trends. This does not indicate a sign of serious financial instability. For the past five years, sales have been growing at an average rate of 4.53 percent. Maybe small, but ALU's sales growth is actually very close to what some of its major peers have achieved. For example, Cisco Systems (NASDAQ:CSCO) has a 5-year average sales growth of 5.69 percent while Ericsson's (NASDAQ:ERIC) same variable stands at 4.76 percent.
In times of poor economic activity, customers' purchasing power is limited. Thus, companies are seeking alternative ways to cope with the market slowdown. Alcatel-Lucent is doing that by focusing on cutting operating and capital expenses. The current debt-to-equity ratio of 0.97 has shown substantial improvement over the past two years. The same stands for the company's financial leverage.
Technically, ALU's year-to-date chart is the definition of a falling knife. The stock's previous close price was 36 percent behind the SMA200 and 7.7 percent behind the SMA50. Throughout 2012, the stock has performed poorly by posting negative returns of 34 percent. ALU's five-year chart is quite discouraging. Over the past five years, the stock has witnessed trends of high volatility making it a rather risky investment.
However, fundamentally the company has some positives. EPS trends indicate a more positive outlook for the company. EPS this year grew by an outstanding rate of 272 percent, while next year's projections suggest an average increase of 200 percent. Moreover, the stock is trading 65 percent below its 52-week range of $2.78 and has upside potential of at least 41 percent based on analysts' mean targets. Also, ALU is trading about half times its book value. Suggesting that the company pursues sound control of its financials, ALU's fundamental metrics could indicate a value opportunity. Trailing ROE of 31.3 is way ahead the industry's average of 8.6, indicating the company's ability to generate growth.
Alcatel-Lucent's strategic position
Despite the market's pessimism over the company's future performance, Alcatel-Lucent remains at the forefront of the industry. The company operates through three business segments: Networks, Software, Services & Solutions (S3), and Enterprise. Each business sector has contributed to the company's emergence as a leading telecommunications provider. In last year, ALU dominated the optical networking market and ranked first among its peers. It held a 35-40 percent market share based on revenues in submarine optical networking, and a 53 percent market share in packet microwave transmission. ALU ranked second in LTE with a total market share of 24 percent and was responsible for 44 percent of the VDSL2 market. Moreover, the company's S3 segment managed service deals for more than 100 networks covering about 250 million subscribers.
Most importantly, throughout 2012, Alcatel has sealed several deals, which are going to strengthen its position and enhance its backlog. Earlier this year, ALU signed a contract with China Telecom (NYSE:CHA) agreeing to deliver high-speed broadband connections to 250 million Chinese households. Just for October 2012, the company announced strategic collaborations with Türk Telekom, Telesis Tanzania, JGC Corporation and California State University - CSU.
The company is about to release Q3 2012 financial results, which I anticipate with great interest. ALU's first priority should be the improvement of its margins. While gross margin of 33.08 percent is decent, operating and profit margins are ugly. I do not expect the company to change that overnight.
ALU faces some risks that justify up to a point the current market sentiment. For example, even though it operates internationally, 30 percent of its income derives from financially distressed European economies. In addition, with more than 70.000 employees, ALU spends a fortune on pension funds. The deals ALU made throughout 2012 are going to provide a safety cushion by adding cash to the company's accounts. However, understanding market dynamics and adjusting to the telecommunications transformation process is the key to success. Overall, I do believe that ALU is far from being over. The company has serious upside potential if it plays its cards right.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Business relationship disclosure: EfsInvestment is a team of analysts. This article was written by Fani Kelesidou, one of our equity researchers. We did not receive compensation for this article (other than from Seeking Alpha), and we have no business relationship with any company whose stock is mentioned in this article.