Adtran: Little Expected, Little Delivered

Richard is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Communications equipment maker Adtran (NASDAQ: ADTN) has become a tough stock to figure out. In many respects, the stock looks cheap. But it comes with a considerable amount of risk. Worryingly, its biggest customers account for almost 50% of its revenue. And unless carrier spending returns to its previous lofty levels, Adtran may find it exceptionally challenging to escape the vulnerabilities of the sector’s cyclical swings. That grim outlook has not escaped investors, and Adtran's Q3 report did little to extinguish their fears.

Q3 report showed little improvements
On Wednesday, the company reported net income of $9.3 million, or $0.15 per share, on revenues of $162.1 million – representing an EPS and revenue drop of 74% and 15%, respectively, from the same period of a year ago. Aside from missing analysts’ estimates on both the top and bottom lines ($0.31 EPS and $190.2 million in revenue), the company is experiencing both profits and sales deterioration.

Even more concerning, Adtran's net income and gross margins have fallen for four straight quarters. Consequently, estimates for the company’s Q4 have dropped recently from $0.54 to $0.36 per share, while its EPS target for the fiscal year has been reduced by almost 30%, to $1.20.

Nonetheless, management remains optimistic about its prospects. Despite the company’s disappointing quarter and what is considered an unfavorable outlook among investors and analysts, Adtran’s CEO, Tom Stanton, felt good about the company’s position in the market. He believes that globalization efforts will lead to significantly better performance in the future.

It’s all about carrier spending and competition
The company has no future unless it immediately reverses its recent string of disappointing performances. I don’t see how a market already filled with pessimism will allow it the time it needs to figure things out. Waiting on Adtran essentially requires waiting on carrier spending to recover. The stock definitely has value, but to realize it, investors must perfectly time that recovery. This is not an easy proposition, particularly since it appears that major Adtran customers AT&T and Verizon seem more interested in capital reinvestments that do not involve buying new gear.

At least Adtran is not alone in its struggles. Rivals such as Acme Packet (NASDAQ: APKT), Alcatel-Lucent (NYSE: ALU), and Ciena (NASDAQ: CIEN) are all battling the weak spending environment – particularly Acme Packet, since 80% of its revenue comes from carriers. Meanwhile, Ciena recently reported an operating loss of $4.1 million, while missing revenue estimates.

But these struggles can’t continue forever. At some point, carrier spending will return, and the company best positioned to deliver the right mix of equipment and communication services at the right price will win. But will Adtran be that winner -- or even a contender?

I would imagine that the entire sector will make growing revenues and market share their greatest priority. With Adtran’s margins already on the decline, it’s hard to say at this point what impact the competition will have. But increased pressure will make any type of recovery that much harder.

Bottom line
Adtran is a good company with a sound management team – one that appears to weathering this storm as well as it can. However, investors have to become more realistic about its growth prospects, since Adtran's expansion won't arrive in the quantities that the Street expects. 

Bulls would argue that its fundamentals are solid. Perhaps, but too many variables and conditions need to go right for this stock to work. Until the company can prove that it can put more than one good quarter together, while also showing that it can grow its margins and distinguish itself from rivals, I wouldn't buy into Adtran.


rsaintvilus has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. Motley Fool newsletter services recommend Acme Packet. 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.If you have questions about this post or the Fool’s blog network, click here for information.

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