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Thursday March 8, 2:20 pm Eastern Time
SmartMoney.com - Stock Watch
Telecom Equipment: Catching Knives
By Cintra Scott
BUYING TELECOM-EQUIPMENT stocks can be a little like catching falling knives, advises Lissa Bogaty at Credit Suisse First Boston. But that's old news to investors who ``bought on the dips'' last year, only to see the stocks plummet to an average of 70% below their 52-week highs. Consider Cisco Systems (NASDAQ:CSCO - news), which traded for as much as $82 a share last March. On Friday, Cisco hit a new 52-week low of $21.94, alongside other erstwhile highfliers like Juniper Networks (NASDAQ:JNPR - news) and Redback Networks (NASDAQ:RBAK - news).
But instead of crying over spilt, er, blood, we decided to look at Cisco and Co. in a new light. Here's our post-bubble report.
The bad news is that as telecom customers cut budgets for new equipment, earnings projections for the sector have tumbled with surprising speed. Witness the earnings warning by JDS Uniphase (NASDAQ:JDSU - news) on Tuesday — its third in six weeks. The company said that it can't stand by projections for the rest of the year. Hardly a comfort given that analysts last year were calling the company's high-end gear immune to a downturn.
The good news, however, is that stock prices have been falling even faster than profits, depressing price-to-earnings ratios. That means some telecom-equipment stocks not only look cheap compared with their 52-week highs, they're also looking cheap relative to their five-year historic P/E averages.
These stocks are still expensive relative to the rest of the market. And given the capital crunch infecting the industry, there are some big questions surrounding short-term earnings growth. But we haven't been shy about proclaiming this sector one of the most promising in the business. It sits at the sweet spot of the Internet/wireless build-out. And that, we believe, is still in its infancy (see this week's Tech Market by Tiernan Ray).
A number of these stocks still defy gravity. Consider Sonus Networks (NASDAQ:SONS - news), which makes a new breed of switches to direct network traffic. Its growth prospects look good so far, but the company still spends more than it brings in. And the stock's price-to-sales ratio is also a stomach-churning 102. (Meanwhile, the average telecom-equipment stock trades for 12 times sales.) Corvis (NASDAQ:CORV - news), too, is currently trading for 46 times sales, and ONI Systems (NASDAQ:ONIS - news) is trading for 68 times sales. Even the profitable Ciena (NASDAQ:CIEN - news) still trades at a premium — 90 times earnings and 18 times sales. We won't knock these companies' innovative products, but we remind investors that the law of gravity can strike defiant shares at any time.
But gravity has already gotten hold of industry leaders like Cisco and JDS. And both companies continue to have enviable management teams, dominant market positions and extensive product offerings. In short, if you believe in the Internet revolution you should own both of these companies. And this is a legitimate buying opportunity. At a 12-month P/E of 33.6, Cisco sits 50% below its five-year average, despite a projected three- to five-year earnings-growth rate of 33%. JDS is resting at 41.2, 65% below its average. Its projected growth rate is 45%.
The short-term outlook for these companies isn't exactly rosy, which is to say they may not have bottomed yet. Right now, inventory build-ups among customers remain a concern, since they're dampening sales. The same companies that were ordering as many routers as they could from Cisco a year ago, for instance, are now more concerned about making the best use of the routers they've already got. Perhaps they're even buying routers from the failed dot-com down the street. Indeed, near-term sales projections for routers, switches, cables and components all seem to drop every week.
On Tuesday, after the market closed, JDS chose an appearance at Thomas Weisel's telecom conference to disclose that sales and earnings look even weaker than anticipated, thanks to a slowing economy and inventory corrections. Just a few months ago, JDS's biggest challenge was meeting high demand. But note that Wall Street Journal All-Star analyst George Hunt of Wachovia Securities is keeping his Buy rating on the stock in place. The reason: JDS's stock has fallen faster than earnings expectations.
The verdict on Cisco is similar. ``I'm cautious about calling a bottom, but Cisco is fundamentally a very good company,'' says Tom Lauria of ING Barings. Lauria recommends the stock to long-term investors because he's ``very confident'' the company can continue to boost sales, which totaled a staggering $19 billion last year. In the near-term, a company like Ciena may have better visibility, but Ciena also has far fewer customers. Its outlook could turn on a dime.
Collectively, Wall Street analysts have lowered their opinions of Cisco 10 times in 2001 alone. And while Cisco can still take credit for supporting more than 80% of Internet traffic, its stock trades for less that the shares of Bed Bath & Beyond (NASDAQ:BBBY - news) and Harley-Davidson (NYSE:HDI - news) based on 2001 earnings estimates. If you think the Internet has less durability than linens or road hogs, then fine. But we'd say you'd be missing an opportunity.
Willing to grab at falling knives in search of some tech upside? At least Cisco and JDS have handles. |
