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Stephen Percoco, CFA
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Steve Percoco founded Lark Research as an independent provider of investment research in 1991. He has been the publisher of the Income Builder newsletter since 2001. He is a generalist, but focuses on several key sectors, including housing (and the homebuilders), real estate, utilities... More
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  • Some Thoughts About Alcatel-Lucent's Q2 Earnings Warning 5 comments
    Jul 18, 2012 10:08 PM | about stocks: NOK, NOK, ERIC

    Today, Alcatel-Lucent warned that it was likely to report a second quarter adjusted operating loss of €40 million with revenues above € 3.5 billion. It said that the revenue figures reflected good sequential growth in sales across all divisions and geographies, but profits did not improve as much as anticipated because of a slower than expected improvement in the business mix. The company made good progress in reducing fixed costs by about €100 million compared with the 2011 second quarter. Even so, with a net adjusted operating loss for the first half of the year, ALU said that it would not be able to achieve its previously announced adjusted operating margin guidance for the full-year 2012. That guidance had called for 2012's adjusted operating margin to be better than 2011's 3.9%.

    Based upon the company's disclosure, 2012 second quarter revenue of more than €3.5 billion is up more than 9% from the first quarter, but down about 10% from the 2011 second quarter. The anticipated second quarter adjusted operating loss of €40 million is a big improvement over the first quarter's adjusted operating loss of € 221 million, but also much worse than the 2011 second quarter's adjusted operating income of €108 million. The operating loss figures imply an operating margin of minus 1.1%, compared with minus 6.9% in Q1 and plus 2.8% in 11Q2. It is evident that ALU made good progress from the very difficult first quarter, but it still has work to do to reach what would be considered a normalized operating margin in the mid-single digit range.

    Today's press release did not address the second part of the company's 2012 guidance: to end the year in a strong net cash position. Based upon the figures reported today, ALU's second quarter cash flow performance will probably not raise additional concerns, but it may not alleviate concerns either, since the company may be required to increase working capital somewhat in anticipation of a modest increase in sales in the second half of the year.

    It is possible, but hopefully not likely, that the disappointing second quarter results will renew speculation that Ben Verwaayen will be forced to step aside. If he does, I would view it as negative for the company. Most of ALU's problems are, I believe, market-related. Since the merger and under Verwaayen's leadership, ALU has made excellent progress in regaining its competitive edge, both in the wireless and the IP businesses. I believe that the company is uniquely positioned to benefit from the increased demand for product and services that integrate, streamline and optimize the data flow from both wireless and wireline broadband traffic from the network edge and through the backbone.

    ALU is especially challenged by the slowdown in capital spending by European telecom carriers. That combined with global telecom equipment supplier overcapacity has put pressure on both revenues and margins for all competitors. A little over one week ago, the Financial Times reported that Brussels was considering launching an investigation into subsidies given by the Chinese government to Huawei and ZTE, the telecom equipment manufacturers. China has threatened to retaliate, but it is clear that the European authorities understand the pressures that the industry faces and may very well try to take some steps to alleviate them.

    In this environment, it is also unclear whether Nokia-Siemens Networks can continue to operate as an independent entity. Nokia clearly has a lot on its plate. Although it incurred significant charges in the first quarter to restructure NSN, it is not clear whether NSN will continue to require support, which Nokia may not be able to afford. The industry would obviously be better off with one less competitor, but the European Commission may find it difficult to approve further consolidation among the remaining suppliers.

    For now, the disappointing second quarter results will likely lead to lower earnings estimates for ALU for 2012. Analysts had anticipated earnings of $0.02 for the second quarter. Based upon today's disclosures, I pencil out a loss from continuing operations (including restructuring charges) of about $0.05. Current consensus estimates anticipate full-year 2012 earnings of $0.17 for ALU. With an estimated $0.14 in losses from continuing operations for the first half of 2012, a more realistic full-year estimate is probably now around $0.10.

    ALU's shares fell 19% today to $1.11, which gives an implied P/E multiple against my 2012 estimate of about 11 times. Considering that this should be trough earnings, the stock looks very cheap. If the outlook for global economic growth improves, as I anticipate it will, led by a pick-up in the U.S. growth rate, then telecom carriers around the globe will begin putting more upgrade projects on the front burner. This is the upside scenario for ALU and most of its peers. In "normal" times, it is not unreasonable to think that ALU could earn $0.30 to $0.45 per share, which would probably translate into a stock price of $3.50 to $5.00.

    With net cash (i.e. cash minus debt) of €753 million at the end of the first quarter, the company should have the financial wherewithal to muddle through this rough patch. It cannot afford to be complacent, however, since it potentially faces significant debt maturities beginning in 2013. Ideally, I am sure that the company hopes to see some meaningful improvement in its financial performance in the second half of 2012 to put it in a stronger position to issue new debt perhaps early in 2013.

    Disclosure: I am long ALU.

    Stocks: NOK, NOK, ERIC
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Comments (5)
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  • DanTheMan1984
    , contributor
    Comments (1359) | Send Message
    interesting take thanks for your article I am long ALU with over 5,000 shares. I really want to see the company cut more jobs every year they have falling sales so should that not result in a lower head count. I don't think Verwaayen has been agressive enough in these areas of selling additional product lines, which would help bolster there cash position further. your thoughts?
    24 Jul 2012, 01:30 PM Reply Like
  • Stephen Percoco, CFA
    , contributor
    Comments (102) | Send Message
    Author’s reply » I believe that management has been sufficiently aggressive in addressing its cost structure. The current program to reduce operating expenses by EURO 500 million was a response to the weaker revenue outlook at the beginning of the year. Presumably, the reduction in costs also addresses head count, but I think that the company is mindful of preserving its full service capabilities as much as possible. As for selling additional product lines, here too I think that management has sold non-strategic assets in recent years and may consider other sales, if the sales outlook remains grim. In this case as well, it must balance the need to remain profitable against its ability to deliver a full range of services to its key customers which is one of its primary competitive strengths.
    24 Jul 2012, 02:20 PM Reply Like
  • DanTheMan1984
    , contributor
    Comments (1359) | Send Message
    I hope your right, but has management done enough if you think about it? the stock is sitting at 1.10 and is down 80% in the last year! I know some of this is out of the company's control. But year after year Mr.Verwaayen has missed operating margin targets and had to reduce the company's forecast, he's been on the job for almost 4 years now while his 2 predecessors who were the architects behind the Alcatel-Lucent merger were only given two years. I thought he had this company turned around when the company reported 4th quarter and full year results for 2010 back in February 2011 the stock would go all the way up too 6.50 by may of 2011 but ever since then it's been nothing but downhill. Yes I know Europe is struggling and some of the telecom company's have cut back on spending, but still ALU has dropped 80% in it's share price. Furthermore this company has struggled ever since the merger which is almost 6 years ago. How much longer before they turn it around? How much longer does Verwaayen have? I know the hear has been on him and I know he's a good guy he's forewent some stock options and such, but he's managed to turn ALU who has Bell Labs into a penny stock practically, this company has one of the best R&D Houses in the world, they should be thriving not declining. What do you think? As far as Thursday goes most of the bad news is already known don't think were going to see a wild swing downward in the share price. I do think however if they show improvement in there cash burn you might see a relief and a uptick in the price per share.
    24 Jul 2012, 05:40 PM Reply Like
  • Stephen Percoco, CFA
    , contributor
    Comments (102) | Send Message
    Author’s reply » I can't really argue with you on many of your comments. I think they are spot on. Managing the stock price is, after all, a big part of managing a public company. In that regard, Mr. V. did get the stock up to $6.50, which made shareholders happy for a while. At times, the stock's reaction both on the extreme upside and the extreme downside has seemed nutty to me; but then again, these moves are not way out of line with the way European stocks in general have traded at times over the past couple of years.
    Since the sales and earnings figures have been prereleased, I also think that the focus on Thursday's conference call will be on the company's cash flow. As you say, if the burn is less than feared, the stock should at least get a bounce. I am also hoping that they will be more granular about the sales outlook and the prospects for margin improvement through a changing sales mix.
    I was happy that the company preannounced the earnings miss this quarter. Especially after last quarter's disappointment, I think the preannouncement shows greater consideration for the plight of shareholders and also that management is on top of the situation. Guidance from this management has traditionally been skimpy, which is OK in an uncertain environment, but I also would like to see them be a little more forthcoming with whatever "less uncertain" information they have. I think that while you can point the finger at Mr. V. for turning ALU into a penny stock, as you say, I also know that this has been a very tough environment for virtually all telecom equipment companies. ALU has a tougher task because it is trying to embrace the full spectrum of product and services on a limited capital base. You can argue that they should cut back and they might eventually be forced to, but this breadth of service makes them unique and frankly, they seem to be positioned extremely well for where the telecom and equipment services business is heading. We just don't know at this time whether shareholders will fare well at the end of all this. Of course, a lot depends upon the global economic outlook.
    For now, the stock looks cheap at 11 times a more conservative 2012 EPS outlook and a price/book of 0.4 times. Expectations are really low and if the outlook brightens a bit, especially in Europe, there should be meaningful upside potential on the stock. My price target is still around $4.
    24 Jul 2012, 09:44 PM Reply Like
  • DanTheMan1984
    , contributor
    Comments (1359) | Send Message
    Thanks for the talk, and your insight.
    The one thing you mentioned that still gives me hope with ALU is when you said "they seem to be positioned extremely well for where the telecom and equipment services business is heading".
    Call me crazy but I still believe a little bit of me this could be a double digit stock again someday. If you think about it with some of there products they have in the pipeline Light-Radio, FP3 Processor, the new XPS7750 router that's faster and more power efficient then Cisco's. Small cell technology, 4G LTE, There IP Division is growing stronly, also HLN Network (High Leverage Network) . Also the patent portfolio of 30,000 and licensing them out.....
    Mr Verwaayen always mentions the new stuff and the the pipeline is strong, I am interested to see if the products mentioned above are just hype or if they can bring ALU to a new level and what kind of profitability margins they have. The Light Radio is the one that is most talked about, and I really don't see the competition matching some of these products I named, the thing it's always next year with this company, well at the rate ALU has been going we might not have to many more years left, but in the back of my mind I know most of these products I think hit by the end of 2012, if they can;t make it in 2013 with these products and hopefully a recovery in Europe and elsewhere I don't think ALU ever will....what's your take on the pipeline and some of these products? I like the 4 dollar target price I hope it can even go higher, I think my cost average is about 4.15 or so. Thanks again for the talk.
    24 Jul 2012, 11:44 PM Reply Like
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