Alcatel Potentially A "Sell", Better Off With Cisco, Qualcomm
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With telecom seeking to consolidate in the years ahead, the sector is bound to create winners and losers for its end markets. I find myself optimistic about communications equipment providers Cisco (NASDAQ: CSCO) and Qualcomm (NASDAQ: QCOM) and reserved about Alcatel (NYSE: ALU). Over the years, Alcatel has lost the luster of its brand; unlike Cisco and Qualcomm. Currently its a highly volatile stock that may generate high or low returns. Even though financial theory argues that investors will be, overall, compensated for backing riskier assets, there are still instances when a company teeters to close to bankruptcy and is worth a "hold" at best.
Alcatel is one of those rare multi-billion dollar companies that are also penny stocks as defined by the SEC. Last year, the company generated only $113M in operating cash flow while spending $558M in capital expenditures, which nets for negative free cash flow of $445M. At least, CAPEX is falling while cash flow improves, but progress altogether has been too slow. By the time the company reaches positive free cash flow, the global economy may have already reached its inflection point going into accelerating growth.
On the other hand, Alcatel appears cheap with a PE multiple of 6.8x and a PEG ratio of 0.7, suggesting that future growth has yet to be fully factored into the stock price. Alcatel also has the only problem with this; it appears the company will generate only single-digit growth, ROA, ROE, and ROI, which underperforms peers and the broader market. The greatest hope that the company has going for it is not its current fundamentals, but its $880M cash holdings that could be used in transformative takeover activity. Alcatel desperately needs to remake its brand image lest it fall into oblivion altogether.
By contrast, Cisco and Qualcomm are inherently safe and valuable investments. Cisco trades at a respective 12.1x and 8.5x past and forward earnings versus corresponding figures of 19.2x and 13.3x for Qualcomm. Unlike Alcatel, Cisco is also a free cash flow machine. The $87.4B company generated $8.9B in free cash flow last year, and it has not seen levels meaningfully below this amount in the recent term. 2013 EPS is expected to $1.92 and then grow 9.8% in the near-term, which means 2016 EPS of around $2.54. At a 15x multiple and a 10% discount rate, the present value of future earnings is $23.66, which provides an attractive 45% margin of safety. ROA, ROE, and ROI are mostly in the double-digits, and analysts are currently rating the stock near a "buy" according to FINVIZ.com. No analyst has given the firm a price target below its current valuation.
Qualcomm is the largest communications equipment provider described herein but nevertheless has plenty of growth ahead. Over the past 5 years, Qualcomm proved its worth with impressive 13.4% annual EPS growth. Analysts now expect roughly 120 bps more over the next 5. That translates out to 2016 EPS of approximately $6.25. At a 15x multiple, Qualcomm's future stock is worth $93.75, and, in present terms at a 10% discount, the stock is worth $58.21. This does not provide an attractive value discount, but analysts nevertheless rate the stock a "strong buy" according to FINVIZ.com. ROA, ROE, and ROI are also the highest for Qualcomm.
The leading communications equipment provider is also replete with cash. Its assets, moreover, are not tied up in inventory, as indicated by the quick ratio of 3.3. In fact, the company has $13.9B in net cash, which should be used for accretive takeover activity in securing Qualcomm's lead. Telecom is undergoing massive innovation with 4G implementation and smartphone development. By taking the measures now to court clients and future wins, Qualcomm will expand its value potential and outperform broader indices.
TakeoverAnalyst has no positions in the stocks mentioned above. The Motley Fool owns shares of Qualcomm. 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.
