Is Adtran a Smart Buy?
Soroush is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Two weeks ago, telecom networking equipment company Adtran (NASDAQ: ADTN) missed Wall Street’s earnings expectations; the stock has lost over a quarter of its value since. In 2012 alone, shares of ADTN are down by more than 30 percent, falling flatter than the communications equipment industry (-9.32%), and competitors like Juniper Networks (NYSE: JNPR) at -27.4%, Cisco Systems (NASDAQ: CSCO) at -16.4%, Ciena Corp (NASDAQ: CIEN) at 19.0%, and Ericsson Telephone (NASDAQ: ERIC) at -16.1%. While bears can point to this most recent setback, a linchpin for months of underperformance, the subsequent selloff may have provided an entry point for value-seeking investors, giving weight to the old adage: “Be greedy when others are fearful.” Here’s our top 10 list all Buffettologists should follow.
In a post-recessionary environment typically devoid of high-growth telecom players, Adtran has bucked the trend, posting higher 3-year average revenue growth (12.7%) than industry norms (-3.5%), and the likes of JNPR (7.6%), CSCO (3.0%), and ERIC (2.8%). Impressive operating (23.3%) and net (17.1%) margins have allowed the company to squeeze solid profits from this revenue stream, explaining why ADTN has averaged 20.2 percent earnings growth over the past three years.
From a valuation standpoint, Adtran looks cheap most ways you slice it. Using the price-to-earnings ratio, we can see that the stock is trading at a P/E (11.6X) below the industry average (19.8X), and at a forward P/E (10.8X) below peers JNPR (13.2X) and CIEN (30.0X), but slightly above CSCO (7.5X) and ERIC (10.2X). When growth is factored into the equation, shares of ADTN sport a PEG ratio of 0.7; typically any figure below 1.0 signals undervaluation. In comparison to historical levels, this low valuation is even more pronounced. Over the past half-decade, the company’s earnings have traded at a 13 percent premium to those of the S&P 500. This year, they appear cheaper, trading at a 22 percent discount.
At first glance, an undervaluation may seem warranted, as the company’s earnings are expected to shrink to $1.20 a share by the end of 2012, down from the $2.12 it reported last year. By 2013, EPS is expected to grow to $1.59 a share, though, and current prices indicate that the markets are over-discounting for these declines. Specifically, fairly valued shares of ADTN should be trading near $24 a share; they currently trade in the $20 range. By the end of next year, the stock can eclipse the $30 mark if analyst consensus holds. Now, we realize that this sounds like a big if, but there may actually be a few macroeconomic tailwinds on the company’s horizon.
On the whole, demand for network capacity is bullish, which is obviously good news for high-speed network product-makers like Adtran. Due to the carriers’ increasing reliance on smartphones and tablets, any developments – such as the proliferation of 4G LTE systems – in this area will be a boon for the company. A $7 billion government-supported broadband improvement project will also aid private sector demand drivers. One particular trend in this marketplace is known as “convergence” – the phenomenon of one provider offering phone, computing, and cable services in one package, particularly for business communities. Adtran’s recent purchases of the WLAN company Bluesocket and Nokia Siemens Network’s broadband business may give it a leg up on its competition, so to speak.
Even more impressive, is that Adtran is currently sitting on a mountain of cash, holding over $140 million in free cash flow. Over the past year, the company has grown its operating (62.4%) and FCF (67.5%) hoards quite nicely, easily outpacing the majority of its peers in the communications equipment industry. Despite this strong growth, shares of ADTN are trading at a price-to-cash flow ratio (9.8X) below industry norms (10.6X) and its own 5-year average (18.0X). With a PCFG ratio of 0.9, it appears that the markets are not fully accounting for this growth.
WealthLift’s Sentiment Index rates Adtran as a hold, with the community’s user base split on what the future may bring. Ardent investors would be wise to follow the company’s next earnings release, which is set for later this fall. Check back at WealthLift INSIDER for an update on this situation.
Fool blogger Jake Mann doesn't own shares in any of the companies mentioned above. The Motley Fool has no positions in the stocks mentioned above. 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.