Alcatel-Lucent (ALU) was one of the best performing stocks of the last year and the impressive performance of the restructuring plan of the company has helped the stock gain substantial value. I last wrote about the stock at the end of February - in this article I discussed ALU's deal with Intel (NASDAQ:INTC) and how the management was trying not to get into price competition. At the time of writing that article, the stock was trading over $4 and it has lost over 9% in value since then - currently, ALU's stock is trading for $3.90 per share. The decline in the stock price is not a surprise as the whole market has seen a downward trend over the last few weeks, and a number of rapidly growing companies as well as turnaround plays have lost value.
In terms of the strategy and the fundamental progress; Alcatel-Lucent is on track. We are seeing growth in the gross margin of the company. At the end of the last quarter we saw ALU report an improvement of over 200 basis points in its gross margin, mainly due to the focus on high-profit contracts. As a result of shifting the focus to the high-profit contracts, the revenues of the company continue to decline. A business can bring down the costs to a certain extent, and in order to have sustained profitability; it needs to grow its revenues at a consistent rate. However, in case of ALU, we can still see some further decline in costs and improvement in margins. Eventually, the company will need to grow its top-line to have sustained profitability.
An important factor for growing the top-line for ALU will be its presence and connections in China. The company recently signed a one-year agreement with China Mobile (NYSE:CHL) - ALU will help China Mobile in moving to all-IP ultra-broadband network - the total worth of the contract is close to $1 billion. China Mobile is the biggest telecom company in the world with more than 750 million subscribers. Furthermore, the country will have over 400 million Smartphone users during the current year and over 100 million LTE subscribers by 2016 - China Mobile's decision to partner with ALU is hugely encouraging news for the company. Furthermore, ALU is expanding its roots in Asia as this region will be growing at a rapid pace when it comes to 4G-LTE and ultra-broadband market. The second largest telecom company in Thailand, DTAC, has selected Alcatel-Lucent to upgrade its 3-G network and help the company move to 4-G LTE. DTAC serves about 40% of the total population of the country and ALU has partnered with another major player in a growing market.
The company also continues to work on decreasing its costs and sell under-performing assets. The progress on "the shift plan" has been impressive and we will get further update when ALU reports its earnings on May 09. I have talked about the cost cutting and asset sales in this article, and I will not discuss the shift plan in this article. However, I do believe that we will hear more positive movement on the plan and the company will announce further cost reduction with its earnings announcement.
So far we have talked about the company's efforts to enhance its top-line by focusing on high-profit contracts and decrease costs through "the shift plan". Let's now talk about the valuation of the stock. ALU has gained over 100% during the last twelve months - however, the growth in the stock price has been backed by the growth in the company fundamentals. Despite considerable growth (200 basis points) in the gross margin, the operating margin as well as the net margin of the company remains negative. However, when we analyze a company in a turnaround, we do not look at the numbers in absolute terms - it is best to make a comparison with the company's own performance in the past. At the end of 2012, ALU's operating margin was close to -11.5%, which has come down to -5.16% during the last year - we have seen an improvement of over 6% in the operating margin of the company. The net margin has also shown the same trend - ALU had net margin of -14.45% at the end of 2012, which came down to -8.9% by the end of the last year. Another proof that the strategy of the company is working and the shift plan has helped ALU.
I usually do not talk about options in my articles as the topic is tricky and I do not recommend the use of options for inexperienced traders. However, I will use the movement in the options market in order to highlight the market expectations in the short-term. The activity in the ALU June calls with a strike price of $4.33 has been unusually high and a total of 12,000 call options have been traded. This indicates that the investors are expecting the company to report better than expected results and they are betting on the positive news to push the stock over $4.33 per share by the end of June. I am also expecting the company to report further improvement in the cost structure and gross margin, and the speculators might end up making profits on these call options. Again, inexperienced traders should stay away from options as it might result in the total loss of the investment if the stock does not make the expected move in the time frame of the contract.
The recent fall in the stock price has offered its long-term investors a very good opportunity to add to their positions, in my opinion. I believe the company is on the right track and strategy is being executed nicely. ALU shareholders should be patient and hold onto their holdings. I am optimistic about the prospects of the company due to the vision of the management. I believe the fears about the demise of the company are overstated. In fact, ALU has left that condition behind and its recovery is now entering a phase where we will see it gather some momentum.
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. This article is for educational purposes only and it should not be taken as an investment recommendation. Investors are urged to do their own due diligence before making any investment decision.