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This Stock Has Multiple Catalysts, but Should You Buy?

Monday - 7/15/2013, 2:58pm  ET

It seems like some investors are really confident about telecom gear maker ADTRAN’s prospects. While the stock fell close to 7% after the company’s second-quarter results as it expressed concerns over the gross margin performance of its European business, the bulls were back the next day and ADTRAN recovered to some extent, probably on the back of the company’s optimism regarding improvement in its end markets.

The stock has had a pretty turbulent ride this year, but is still up close to 25%, with most of the gains coming after ADTRAN reported a solid quarter three months back. However, it looks like there are mixed opinions about the stock judging from the reaction after the earnings release, but look a bit deeper and the good points about ADTRAN will emerge.

Getting better

The stock has performed well, but the same can’t be said of the business. However, the last two quarterly reports have been decent and there are signs that ADTRAN might be improving. So, even though the company’s revenue declined 12% from the year-ago period and adjusted earnings of $0.21 per share were also lower, the results were nevertheless better than consensus estimates.

The company’s performance was driven by the strength of its enterprise business and improvement in the EMEA region. Moreover, it witnessed better spending from its Tier 3 carrier customers and gained market share at Tier 2 customers. So, ADTRAN witnessed sequential improvements in both its carrier networks business and the enterprise business.

ADTRAN’s broadband access business has been doing well of late and the trend continued in the previous quarter as well, while internet working product sales have been driving the enterprise side of the business.

Notable moves

Going forward, management expects further improvements and this is what has probably provided some confidence to investors. The company has been landing new contracts and is counting on a stronger spending environment in its enterprise business and telco infrastructure upgrades.

One of ADTRAN’s enterprise products, NetVanta, was chosen by a major Tier 1 carrier in Europe, and ADTRAN also became a primary vendor for wireless LAN services to a Tier 1 and a Tier 2 carrier in the U.S. In addition, the company is well-positioned to gain from the upgrade activity of two major carriers -- one in the U.S. and another one in Europe.

While shipments to the European customer are expected to begin this quarter, revenue from the domestic carrier is expected to come in from next year, which indicates that ADTRAN is gradually gaining strength as telecom spending improves. The company is positioning itself to benefit from the roll out of faster networks and sees upgrades across the globe as major opportunities.

Upgrades to drive growth

As we’ve seen with other players in the field of networking and communication equipment and components, even ADTRAN is singing the same tune of multi-year upgrades by carriers. Management believes that the evolution of networks has begun and should be a tailwind going forward, and I concur with this belief.

For instance, telecom giant AT&T will be spending $20 billion for upgrading its network in 2014 and 2015 as the company is aggressively moving to deploy its 4G LTE network. Ma Bell’s Project Velocity IP has been progressing well and the company is witnessing robust growth in mobile data. As AT&T continues to roll out its network upgrade, ADTRAN will be one of the beneficiaries of the telco’s capital spending.

Now, AT&T isn’t the only player in the telecom industry in the U.S. and as it accelerates its deployment, the others will also spring into action to keep up with Ma Bell. Moreover, the foray of Japanese telecom heavyweight SoftBank into the U.S. with its acquisition of Sprint should intensify competition, as SoftBank will be pumping in $16 billion in the next two years to expand Sprint’s LTE network.

While Sprint, with about 90 cities covered by its LTE network, is currently lagging behind Verizon and AT&T, its aggressive investments bode well for both shareholders and companies such as ADTRAN which thrive on capital spending by telcos.

So, it’s clear that ADTRAN is looking at multiple catalysts to drive its business. Moreover, management did state over the previous conference call that it is witnessing a rebound in Europe, which indicates that this region might continue to get better gradually as ADTRAN’s major customer purchases its products.

The bottom line

However, there’s a disclaimer. ADTRAN trades at an expensive 50 times earnings and it might not be conducive to buy more shares at this stage. But then, analysts are expecting earnings to grow almost 39% next year and the forward P/E is pegged at 25 times, which means that there is some robust growth expected in the next one year.

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