Network Stocks: 2 Sells, 2 Buys And 1 Hold

by: Richard Saintvilus

By Richard Saintvilus

With corporate earnings once again on the rise, coupled with the tremendous effort that the economy is making to get back on track, all of this should bode well for enterprise stocks. As industry experts anticipates the return of corporate IT spending, network stocks should benefit greatly. But not all are the same. As such, here are two companies to sell, two to buy and one that just needs a few more catalysts.

Sell F5 Networks (FFIV)

Shares of F5 are now at $73 and the bleeding may not yet be over. Before you claim "that's easy for me to say" after the stock has already dropped 20%, please consider that I offered caution to investors back in November and suggested that the stock doesn't make sense.

I also advised caution on February 7 when the stock was at $107 per share. It was clear then that the company was heading down the wrong path. Unfortunately, the Street has just now realized this. F5 didn't have a great end of year quarter as it missed on both top and bottom lines.

In fact, the fourth-quarter, which produced revenue and earnings per share growth of 15% and 6% respectively, was the company's worse in terms of performance in more than three years. But it was no surprise. Plus it didn't help that the company has strong exposure to the weakness in Europe.

Meanwhile, investors ignored the fact that the stock was (then) trading at five points higher than the industry average and more than twice the valuation of Cisco. Meanwhile, Cisco had just completed its seventh consecutive earnings beat.

The fundamental weaknesses in this company, including weak operating margins, which resulted in a 2% decline in operating income, were too much to ignore. The question now is, how much punishment this stock will take.

Sell Juniper (JNPR)

The important question for Juniper continues to be about the overall health of its business. It is interesting when you consider that the prevailing debate has always been which of the two is better when compared to Cisco. Today, analysts are asking if Juniper, which tried unsuccessfully to sell off assets to rivals, can run its business effectively. But it's also been a series of bad news.

Recently, Juniper's stock took another beating, losing more than 5% after Goldman Sachs downgraded the company to "sell" citing "competitive and disruptive pressures." In her research note, analyst, Simona Jankowski stated, "We have greater concerns about Juniper's ability to execute in an environment marked by more rapid disruptive change and heightened competition,"

Jankowski's right. But Juniper has been showing these signs for several months. On the heels of two consecutive disappointing quarters, including a Q3 that missed EPS estimates and produced a paltry 1.1% revenue growth, Juniper managed just 2% growth in its fourth quarter - posting revenue of $1.14 billion. For a stock that was trading at such a premium, this was lightweight production.

Granted, this was enough to top Street estimates, but Q4 also highlighted some weaknesses in Juniper's performance. The fact that Juniper posted a 1% (sequential and year-over-year) decline in product revenue was alarming. While I'm willing to give Juniper credit for improved profitability, better margins don't necessarily translate to better growth or leverage.

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. Over the past year, the company has not been able to do that. And the stock's still too expensive when compared to market leader Cisco.

Buy Cisco (CSCO)

I recently asked if the market is still discounting Cisco. As disappointing as the past couple of years have been, there are certainly plenty of reasons to suspect that the worst is behind the company and it deserves a tremendous amount of credit for what it has been able to accomplish in a relatively short period of time.

I'm not suggesting that this is a flawless company. But there are also several reasons to expect more share gains ahead, including the fact that the company just completed its seventh consecutive earnings beat. In the most recent quarter, year-over-year revenue growth arrived at 5%, while advancing 2% sequentially. This is despite struggles in hardware (routing and switching)

However, as the hardware business has struggled, management has been investing heavily to shore up Cisco's cloud position, while also picking off several companies that strengthen Cisco's software defined networking, or SDN, position. It's been clear from Cisco's recent acquisitions that the company is phasing out its focus on hardware.

This is an excellent strategic move, especially since hardware margins aren't that impressive. The company has become a savvy acquirer and has used the recent macro headwind to its advantage. This is while rivals have been looking for ways to cut costs. What's more, Cisco's strong fundamentals, which include $46 billion in cash, can buy access into many markets.

This is not an advantage that the competition has. All of this makes Cisco still one of the best and safest stocks to own. Based on cash flow projections and sales trends, which includes 22% aggregate growth in services, this stock is worth (at least) $30 per share.

Buy Hewlett-Packard (HPQ)

There's something to be said about Wall Street's less than favorable reaction to the numbers that tech giant Hewlett-Packard recently delivered. I say this because it appears that many analysts had soon forgotten that expectations for the company were already low. But it was nonetheless a good start to what just might be a decent recovery.

Revenue arrived at $28.4 billion; falling 6% year over year and 5% sequentially. However, this was enough to top Street estimates of $27.79 billion. For that matter, revenue was down across all segments. Again, this is not a surprise given CEO Meg Whitman's prior comments about this being a five-year recovery process.

However, the networking division did well -- posting 4% year-over-year growth. For that matter, this is an area where HP should see some improvement going forward. I recently discussed Whitman's managerial ability and suggested that she deserves the benefit of the doubt. So far, she's affirming that she deserves more time to execute.

Whitman appreciates what the company is and what it is not. To that end, she has restored some stability, direction and focus as evidenced by what the company has been able to do in the recent quarter. I think the stock is cheap at this level. With continued improvements, these shares can reach $25 by the second half of the year.

Hold Brocade (BRCD)

In the network category, Brocade is one company that seems to be forgotten. In 2008, the company acquired one of its competitors, Foundry Networks, an acquisition that has paid dividend to Brocade. However, the Street would love Brocade more if the top line was more attractive.

For instance, the stock recently dropped despite the fact that the company beat its own target -- posting revenue of $588.7 million, which represented an increase of 5% year-over-year and 2% sequentially. For that matter, Brocade's year-over-year and sequential improvement were the exact growth levels of Cisco, which, by contrast, the Street applauded. Fairly or unfairly, this has been Brocade's reality.

However, it's a mistake to judge Brocade solely on revenue growth. This is a company that has produced solid free cash flow for eight consecutive years, while margins have always been strong. That the company continues to grow market share in its core storage-are-network business, indicated Brocade's technology is still highly regarded.

While I do like Brocade and see some possible upside in the near-term, this is not by any means a flawless company. The improvements have been positive, but Brocade is still far behind Cisco and Juniper in enterprise data centers.

Elsewhere, the debt to equity situation is not very attractive. The company has $683 million in cash and $900 million in debt. The risk here is that Juniper or Cisco might turn up the heat at any point and squeeze the solid margins that Brocade enjoys today.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: SaintsSense is a team of financial writers. This article was written by Richard Saintvilus, founder of SaintsSense. 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.