Is This Telecom Equipment Stock Presenting Value?

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After an intoxicating rally of more than 60%, during a two month period between December and January, shares of Alcatel-Lucent (NYSE: ALU) have since fallen 22%. The optimism has been shifted to pessimism as the stock now trades with a 4% YTD loss. Therefore, the question remains if whether or not value exists or if it’s a value trap?

Alcatel: A company with value

If you look back on Alcatel-Lucent over the last four years, there have been countless periods of hope and despair. The stock has often risen to the occasion with gains of 50-70%, only to fall back in an abrupt downtrend. Currently, this appears to be occurring, yet the difference is that those same catalysts that led to an end-of-the-year rally in 2012 are still present.

As I’ve mentioned before, Alcatel-Lucent is still presenting value that is second to none in its space. The problem is not only pessimism towards ALU but also towards a variety of companies in the telecom equipment industry. However, my predicted upside, and decision to make Alcatel my ‘Value of the Year” is not based on short-term performance, but rather value that I consider clear; if the company will execute on its plan.

Value doesn’t always produce early

My last year’s “Value of the Year” was Sprint Nextel (NYSE: S), and although we all know its rally from $2.15 to $6.15 now, it wasn’t always clear to all who followed the stock. In fact, what many don’t remember is that Sprint actually traded virtually flat for the first four months, before rallying in the third and fourth quarter. However, I knew that with the company receiving the iPhone and having unlimited data that it was worth more than $2.15, especially considering its price of $5.00 in the year prior.

Now, fast-forward to Alcatel-Lucent, it’s kind of the same situation. Currently, large telecom companies are spending a great deal more on operating expenditures and the company itself has signed countless new contracts with large developing countries. However, the problem with Alcatel is not the business that builds networks for companies such as AT&T but rather the smaller unprofitable businesses that keep it from achieving profitability.

Last year the stock rallied as the company secured financing from Goldman Sachs and announced plans to monetize its patents and divest many of its assets, therefore becoming smaller. However, as I explained in a previous article, Alcatel’s problem is margins, not revenue, and it’s presenting such greater value compared to the industry that it could easily lose a third of its business and triple in value.

Clearly cheap compared to industry

The company is valued at $3 billion yet has revenue of almost $19 billion, making its price/sales ratio 0.16. This compares favorably to the 1.5-2.5 price/sales ratios of other companies in its space. However Alcatel also has an operating margin of just 0.88%, which compares less favorably to the 6-15% of other companies in its space. Therefore, by selling off its unprofitable businesses and keeping its growing and profitable businesses the stock should reflect that of the industry average. Judging by the large gap in value/sales it is obvious that the market places a larger weight on efficiency. Therefore, by becoming more efficient, Alcatel will present more upside than any other company in the space, but only if it becomes more efficient and executes its plan.

Conclusion

The key moving forward is whether or not the company stays on track. It has to make moves quickly to maintain any level of shareholder support. Sprint had this same problem in early 2012, as investors find it psychologically difficult to accept change, and find it psychologically sensible to value a company based on the performance of its stock. However, the key to finding value is finding the inconsistencies between value and performance, as explained in my book. In my opinion, Alcatel is a perfect example. It is a stock that has been beaten to the absolute limit, trading at a deep discount to its worth, and right now has more upside than at any point in the last five years because the company has identified its issues. Therefore, I remain bullish until there is a reason to believe that the company will be unsuccessful at divesting its assets/segment of its business, which I believe will push the stock significantly higher in the second half of this year. 


Brian Nichols owns shares in Alcatel-Lucent. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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