This Stock Deserves Your Love Ahead of Earnings

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

To say that Adtran (NASDAQ: ADTN) had a rough 2012 would be a gross understatement. The telecom equipment maker lost 34% of its value. But Adtran was not alone as the entire sector was ravaged by poor carrier spending. And absent buying its own equipment, there was no way to stop the bleeding.

However, it’s a new year. That industry experts are projecting a healthy recovery in carrier spending, depressed stocks such as Adtran will be in-play. And with the company due to report on its fourth quarter results, investors would be wise to jump in early. To the extent that Adtran can show even modest sequential improvements in performance, cheaper shares might never come.

Can Q4 Validate Q3’s Patience?

Adtran’s Q3 report wasn’t great. But relative to expectations, it wasn’t horrible either. The company reported net income of $9.3 million or 15 cents per share on revenues of $162.1 million. EPS and revenue dropped 74% and 15% respectively. While these numbers do sound horrible, but as noted, Adtran’s struggles were not unique to the company.

Consider that a rival such as Ciena (NASDAQ: CIEN) performed arguably worst. Not only did Ciena’s Q3 results miss estimates, but the company reported an operating loss of $4.1 million on revenues of $474.1 million. Plus the results included poor gross operating margin, which fell by 440 basis points to 39.5%.

As with Adtran, Ciena attributed the disappointing results to “ongoing macroeconomic challenges and slower than expected roll-outs of new design wins” - this according to CEO, Gary Smith. For Adtran, the good news though, is that its customer base consists of three prominent carriers in VerizonQwest and AT&T. The bad news is that they account for close to 50% of the company’s revenue.

Moving Forward

Although the industry is expected to rebound, the extent of the recovery remains unknown. However, that 30% has been shed from Adtran's prior EPS fiscal year targets, including Q4 estimates dropping from 54 cents per share to 36 cents suggests that optimism may not be as high as previously thought.

Nonetheless, management continues to remain optimistic about its prospects. Adtran’s CEO, Tom Stanton felt good about the company’s position in the market and feels that globalization efforts will lead to significantly better performance in the future. I have to agree

At some point carrier spending will return. And the company that is best positioned to deliver the right mix of equipment, communication services and at the right price will win. Why can’t it be Adtran? So far the company has made the best out of a bad situation. But it’s going to require more than just moral victories to win investors.

For that to happen, Adtran needs to get more aggressive in its strategic focus. The company must get out of the mindset of being the best “low cost supplier” in the business. This will not work in the long term. But in the meantime, Adtran remains a good company with a sound management team. That shares lost over 30% last year makes Adtran a possible turnaround candidate – even with modest growth.

Bottom line

Even on the most conservative assumptions, these shares should be trading at $25. Granted, there are plenty of variables before the stock can work. But if revenue growth stays in the mid-single digits and Adtran can produce free cash flow conversions at its historical rate, these shares are undervalued today by at least 30%.

rsaintvilus has no position in any stocks mentioned. 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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