Can This Stock Sustain Its Newfound Momentum?

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

Sometimes people get more than what they had hoped for. A similar thought would have rushed through telecom gear maker ADTRAN’s (NASDAQ: ADTN) investors, after the stock flew on the back of a solid earnings beat. But will these gains be short-lived, or will ADTRAN continue to fly after gaining more than 16% so far this year. And most importantly, should investors add more to their ADTRAN positions at current levels? Let’s find out.

An unexpected surprise

As I said right off the bat, ADTRAN investors would have been surprised at what they saw in the earnings release. The company posted revenue of $143 million, 6% higher than last year and ahead of analyst expectations. ADTRAN saw continued improvement in the business environment, driven by better spending from telcos, while geographical expansion helped revenue further.

However, it was the bottom line beat that took the stock to another level. ADTRAN’s adjusted earnings of $0.17 a share were way ahead of the $0.08 Street expectation. That is a really solid beat, isn’t it? But, to me, it was unexpected. I wouldn’t have been surprised if ADTRAN had just managed to trip across the consensus estimate, but such a big positive surprise took me aback.

I checked for the company’s margins. Gross margin was down to 48.7% from 55% in the year-ago period, while operating income was down almost 60% from the prior year period, and non-GAAP EPS was 25% down. These dour figures didn’t stop ADTRAN from soaring, and it seems that an aggressive share repurchase plan also did the trick for ADTRAN to support its EPS figure.

As UBS analyst Amitabh Passi pointed out, the company bought back $22.5 million worth of shares in the previous quarter, three times the $7.5 million analysts had initially expected. However, the bottom line is that ADTRAN turned in a better-than-expected performance and the shares might have kick started their revival once again.

More positive cues

Positive management commentary helped ADTRAN’s spike further. According to CEO Tom Stanton, the company’s carrier and enterprise businesses are gaining strength, both in the U.S. and internationally. Broadband Access did well once again on the back of higher sales to Tier 1 customers in the U.S. ADTRAN gained share at Tier 2 and Tier 3 accounts as well, and is currently engaged in trials for another product at Tier 1 and Tier 2 customers.

Management also threw some light on the activity of two of its major Tier 1 customers, one in the U.S. and one in Europe. ADTRAN is optimistic that both these carriers will be upgrading their infrastructure significantly, and the company should benefit. The U.S.-based carrier is most likely AT&T (NYSE: T), which is one of ADTRAN’s major customers.

AT&T is beginning to upgrade its networks aggressively, and aims to spend $14 billion on wireless and wireline broadband networks over the next three years. The carrier is looking to cover 99% of its customer locations with “high-speed IP Internet access” in wireline locations, while 75% of locations are expected to be covered in wired IP broadband. These moves should help ADTRAN’s top line going forward.

Moreover, strength in the enterprise business, which grew 14% in the previous quarter, and solid improvements in the international business, which was up 91% from last year, are trends that the company expects to continue.

Such optimism reaffirms faith in a better telco spending environment this year, especially in the wake of F5 Networks(NASDAQ: FFIV) disastrous preliminary results. Last week, F5 lost almost one-fifth of its value in a single day after its preliminary results came in way short of Street expectations. The company blamed delay by its North American telco customers in closing deals which were expected to go through.

However, ADTRAN’s outlook proves that F5’s problems are limited to F5 only, and telecom spending will continue to drive the gear makers’ top line higher.

Whether to buy?

ADTRAN shares have run up 41% over the past six months, and trade at an expensive trailing P/E of 31. Even its forward P/E of almost 25 is quite high, but it does mean that analysts expect growth ahead. Also, ADTRAN sports a dividend yield of 1.9%.

Whether you’ll be buying ADTRAN at these levels depends on your risk taking capacity, since the stock might continue to climb going forward, driven by improved infrastructure spending and its design wins. However, a steep valuation may put off the value investor.

Harsh Chauhan has no position in any stocks mentioned. The Motley Fool recommends F5 Networks. The Motley Fool owns shares of F5 Networks. 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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