GOLDMAN SACHS REPORT 15% GROWTH LONG TERM!!!
Inventory buffer!!!
Guided from 12 billion to 10 billion!!!
OPTICAL SALES DOWN SEQUENTIALLY!!!
$50 target!
Suggestions of stuffing ahead of the bce spinoff!!!
All this from goldman sachs!!
Get the right info and prosper
October 30, 2000
Market Outperformer
Large-Cap Growth
Price: US$50.75
S&P 500: 1398
Canada
Missed the mark; lowered guidance. Total revenue was below
most investor expectations. Previous guidance for optical
revenue of as much as $12 billion this year is now $10 billion. We
have raised our 2000 EPS estimate 2¢ to 72¢ to reflect lower tax
rate, but maintain our 2001 estimate of 98¢.
Stock data Price performance 1M 3M 12M Price performance chart
52-week range $83.88-$27.63 Absolute -5% -21% 129%
Yield 0.1% Rel to Toronto Composite -3% -17% 82%
Capitalization Forecasts/valuation 2000E 2001E
Market cap $188,457mn EPS $0.72 $0.98
Latest net debt/(cash) $0mn P/E 70.5X 51.8X
Free float — ROE — —
Derivatives —
Shares outstanding 2,976.6mn Long-term EPS growth 15%
This report is based on our
October 25th morning note.
Mary Henry
mary.henry@gs.com
Menlo Park: 1-650-234-3337
Ajay Diwan
ajay.diwan@gs.com
Menlo Park: 1-650-234-3311
Natarajan (Subu)
Subrahmanyan
natarajan.subrahmanyan@
gs.com
Menlo Park: 1-650-234-3313
Tina M. Gadwal
tina.gadwal@gs.com
Menlo Park: 1-650-234-3658
Goldman Sachs
Global Equity Research
Important disclosures
appear at the back of
this report.
September-quarter results
Nortel’s September-quarter revenues were $7.31 billion, up 42% from last year but down
6% sequentially. While just shy of our forecast of $7.40 billion, reported revenues were
well below most investor expectations. Operating EPS of 18¢ were up 66% from last year
and ahead of our 16¢ forecast.
Diminished outlook for optical networking business
The optical networking business, which has fueled Nortel's strong growth rate, created
significant concern this quarter. With optical networking revenues down sequentially,
customer “buffer inventory” being drawn down, and the roughly $2-billion discrepancy
between former and current projections for total optical revenues this year, investors have
come to the conclusion that some of Nortel's U.S. customers are cutting back orders.
Negative impact on the sector
Nortel's stock declined significantly, and most of the optical networking stocks were hurt in
the wake of Nortel’s September-quarter results. Investors generally regarded earnings
numbers as in line, but not high enough to sustain Nortel's multiple, which has been one of
the highest in the group.
Nortel Networks Corporation Technology: Communications Technology
2 Goldman Sachs Global Equity Research
September-quarter results raise concern
Nortel's September quarter raised the first concerns that investors have had for some
time about the near-term growth rate of optical networking. While we continue to
believe that the near- and longer-term growth of optical networking will be very
strong relative to most other areas of communications technology, we also think it
makes sense to monitor end-user demand from here to understand if double ordering
or other issues inflated some of the numbers earlier in the year. In any case, it is
probably healthier long term if expectations are reigned in somewhat from the
hypergrowth phase that Nortel has experienced recently, though that process now will
likely result in a much lower multiple for the stock.
Revenues just shy of estimates
Nortel’s September-quarter revenues were $7.31 billion, up 42% from last year but
down 6% sequentially. Reported revenues were shy of our forecast of $7.40 billion and
well below expectations for sales of many investors that were several hundred million
dollars higher than our published forecasts. Operating EPS of 18¢ were up 66% from
last year and ahead of our 16¢ forecast; a penny of the upside was due to a lower tax
rate. On a geographic basis, sales in the United States posted 31% growth from last year
and represented 57% of revenue, down from last quarter's 63%. Canadian sales gained
25%, led by carrier wireline and wireless sales. Europe grew 70%, driven by the optical
business, which has seen growth in excess of 160%. Asia saw a 50% increase in the
quarter. The book-to-bill ratio returned to more normal levels (about 1.05), less than
the unusually high 1.35 seen last quarter.
Revenue and EPS guidance similar to last quarter
Revenue growth guidance for 2000 was in the low 40% range, consistent with the view
given last quarter. Management raised its EPS growth estimate for 2000 slightly to the
low 40% range, compared to its previous estimate in the high 30% range. In 2001,
Nortel continues to expect both revenue and EPS to grow 30%-35%, significantly
ahead of estimated market growth in the low 20% range. We have raised our 2000
estimate slightly to reflect the better-than-expected quarter and the lower tax rate, from
70¢ to 72¢. This implies December-quarter EPS of 24¢, which has been our estimate,
though we lowered our revenue forecast for the quarter slightly from $8.8 billion to
$8.5 billion. For 2001, we maintain our single-point estimate of $0.98 and rounded
estimate of $1.00, but our quarterly progression is now 16¢, 25¢, 23¢, and 34¢, which
is more back-end loaded than our previous 18¢, 25¢, 25¢, and 30¢. Our revenue
forecasts for 2000 and 2001 are now $30 billion (up 41%) and $40 billion (up 34%).
Optical networking drops sequentially
Optical networking continued to drive overall revenue growth this quarter, gaining
90% from last year; however, revenues were down sequentially due to a few U.S.
customers that reportedly drew down “buffer inventory” now that tight delivery
schedules have eased. It surprises many industry observers to learn that there is any
buffer inventory, given the allocation process and long lead times described by Nortel
as recently as last quarter. We think that Nortel encouraged large customers to order
Technology: Communications Technology Nortel Networks Corporation
Goldman Sachs Global Equity Research 3
heavily in the first half, which also coincided with the BCE spin off. Lead times have
gone back to traditional levels, Nortel reports—8 weeks for high capacity systems and 2
to 6 weeks for metro, from lead times that were as high as 20 weeks earlier this year.
Nortel also cited installation issues as a bottleneck to growth in the quarter.
Manufacturing capacity is not an issue at this time.
Guidance for total optical sales this year is down from before
Management expects optical revenue for the year to exceed $10 billion, up triple digits
from 1999 levels. This summer, however, Nortel's management encouraged investors to
think that the business might reach $12 billion this year, so the apparent decline in
guidance is perceived as a big negative. We think that some customers recently pulled
back their forecasts to Nortel.
Strong growth in carrier segment
The carrier segment reported a revenue increase of 54% from last year, driven by
optical, data, and mobility solutions across the regions. Wireless Internet product sales
grew in excess of 50% in the quarter, driven primarily by GSM business. Internet access
product sales were up more than 35% in the quarter due in part to the strong
acceptance of DSLAM product line acquired from Promotory. Similar to last quarter,
core switching increased in excess of 25% for the quarter, fueled by the Passport
15000, which is apparently gaining market share and growing in excess of 100%. As
reported earlier, the Succession product line has also been successful in securing
contracts with major carriers such as Cable & Wireless.
Exhibit 1 shows the revenue breakdown for Nortel.
Exhibit 1: Nortel Networks Corporation, third-quarter 2000 revenue breakdown
Total = $7,314 billion
Enterprise
18%
Other
<1%
Other
<1%
Wireless
23%
Optical
40%
Carrier
82%
Access
9%
Switching/
Services
27%
Source: Company data, GS Research estimates.
Nortel Networks Corporation Technology: Communications Technology
4 Goldman Sachs Global Equity Research
Enterprise growth less robust
Enterprise segment revenue of $1.3 billion was up 6% over last year, attributable to
strength in e-business applications and rejuvenation in data networking, offset by a
slowdown in the voice infrastructure business. Good growth in order input and a strong
performance by the Passport 8600 line leads management to indicate that the
Enterprise segment will see better results in the fourth quarter. Management has made
similar comments in the past few quarters.
Gross margin rises sequentially
Gross margin of 44.0% was up from the June quarter's 42.7% and in line with our
forecast 43.9%. Management indicated gross margin improved in the carrier business
for the quarter, and enterprise margins showed a strong performance but were still
down on a year-to-date basis. Overall margin is expected to be flat for the year relative
to 1999, while management expects to see an increase going forward into 2001. Our
estimates assume gross margin stays near range.
Operating expenses in line
SG&A expenses as a percentage of sales increased 0.9 percentage points (pp) to 18.9%
of sales or $1.38 billion, driven by Nortel's focus to meet customer demand under tight
component and manufacturing constraints, the integration of recent acquisitions, and
the implementation of a supply chain management process. Management expects an
improvement of nearly 1pp in the next year. As expected, Nortel also continued its
investment in optical, IP networking, 3G wireless, and e-business applications, reaching
an R&D expense level of $1.02 billion, representing 13.9% of sales and a 15% increase
year over year. By leveraging common platforms to optimize spending, management
estimates a reduced range of 12.5%-13.5% over the next year.
Balance sheet shows mixed results
Cash and cash equivalents decreased to $1.76 billion from $3.33 billion in the June
quarter. Citing seasonal issues, days of sales outstanding increased to 89 days from 78
days in June. The company still targets an 80-day objective for year-end 2000.
Inventory turns fell slightly to 4.6X.
Upcoming catalysts
We continue to believe that Nortel is one of the best positioned companies in the
sector, with a strong optical market share and product line, very good wireless sales
momentum, and a strong data switching platform. While continued contract news
should be good for the stock from here, the next major catalyst is likely to be better
confidence in the current quarter's growth outlook, which may take several weeks. |
