Alcatel-Lucent's Positive Results Signal Strength for Networking

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

Alcatel-Lucent (ADR) (NYSE: ALU) has been a favorite of mine for almost a year now, and I am still not ready to chuck it into the trash pile. The recent earnings report and price action on the stock has given hope to people who believed in the company’s turnaround. There are things to like and dislike in the recent earnings release, but things seem to be moving in the right direction. The company’s initial success in turning itself around also signals strength for the entire networking industry, which has lagged the overall market recently.

Runt of litter sees success

Alcatel-Lucent did better on revenue than expected by about $0.2 billion, but EPS was in line with expectations of -$0.10. Costs from restructuring and asset impairment charges drove most of the loss. These losses are likely to continue to some extent in the coming quarters. The good news is that operating margins were around 4%, which means the company generated a profit from its operations. Reducing the headcount and restructuring operations will continue to have significant upfront costs, but should benefit the company down the line.

My greatest concern is that Alcatel-Lucent taps the debt market in order to get cash for its restructuring. I know the debt is needed to help the company come out of its slump, but it needs to maintain its debt and run operations on its own steam. I do not want to wait years for this. Cash flow will be the key measure of success for the company, as will it reducing its debt burden without tapping capital markets.

I took my position in Alcatel-Lucent via options. I am holding onto both my 2014 options and 2015 options for now. The 2014 options have gone in-the-money, and I will exit when it feels right. I figure I have a month of time value without risking too much profit, which should be enough to let the stock’s current strength play out.

I wanted to look at the potential of other companies in networking and telecommunications. My reasoning is that if Alcatel-Lucent can increase sales, then its stronger competitors should see some benefit, even if it is a little bit less.

Stronger competitors benefit more

Juniper Networks (NYSE: JNPR) has had a hard time increasing revenue, which is the reason for its less-than-stellar share performance in the last few months. The stock has been doing better lately, as people expected the company to start posting growth as the economy improves.

Juniper reported substantial revenue growth in its last earnings. It beat the top of its guidance by around 5%, which is impressive for a company that has had essentially flat revenue.

However, I like to see the gray cloud for every silver lining. I wanted Juniper to develop some cutting-edge new product that its consumers love. Instead these sales came from existing and updated products. I would like to see it break into the next stage of its products or a logical extension of its existing products.

I am not particularly worried about the shelf filing or the probe into foreign practices. I believe the former will not be significantly dilutionary, and the latter will amount to a fine that would not be much of a problem.

The company offered rosy guidance for the next quarter, which is good news for the stock. I think Juniper can rise higher, around $25 at least, on subsequent earnings reports. The biggest long-term weight on the stock seems to be lifted. My confidence in the guidance is enhanced by the market leader’s strong projections for future growth.

Cisco Systems (NASDAQ: CSCO) tends to be very conservative when it gives guidance. In light of that history, it is not unreasonable to assume that the revenue growth projection of 4% to 7% is at least a little conservative. If revenue growth comes in at 8%, that would be in line with what I would be expecting. That revenue growth is very impressive.

Cisco has shown regular revenue growth despite the lull that networking has been experiencing. It probably has to do with the diversity of Cisco’s business. Net income increased as the company has made an effort to boost its margins by controlling costs. That was the best way to go about it while growth was poor. The earnings beat last quarter really helped wake the stock up from its stupor. The low $20's was Cisco’s prison, but it has managed to hold around $26.

I have yet to retake an options position after closing my last one. I am waiting for January 2015 $40 calls, because the $35's are a bit too expensive. However, if the stock continues to hover around $26 the drop in volatility should accelerate some time decay to give me a good entry. With the growth Cisco is projecting I think next earnings could see Cisco break $30 if they beat again.

Conclusion

More sales equals higher share price might seem like a simplistic analysis, but it seems like the starter pistol I have been waiting for. The story for me is that Alcatel-Lucent is primarily focused on cutting costs right now, and it has seen sales growth. That means that Cisco and Juniper have the chance to see even greater growth, perhaps more than even they expect.

I still like Alcatel-Lucent. Now that the turnaround seems to be seeing some success the last thing I would want to do is bail out. Juniper still strikes me as the most problematic since it is right in the middle. It will probably see its stock go up if it can meet or beat its targets, but I would rather go with Cisco as a long-haul stock. There is a strong chance Juniper will go up, but I would rather take positions at both ends of the risk spectrum. Alcatel-Lucent is my risky choice, and Cisco is my safe choice. If I had more money I would put Juniper in the mid-card.

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Nihar Patel has the following options: long January 2014 $2.5 calls on Alcatel-Lucent (ADR) and long January 2015 $3 calls on Alcatel-Lucent (ADR). The Motley Fool recommends Cisco Systems. 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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