Ericsson at the Margin

If you own Ericsson (Nasdaq: ERICY  ) stock, this could be a difficult moment for you. Ericsson's second-quarter figures out yesterday highlight juicy operating margins of 23%. Plenty of cash in the bank and little debt mean that Ericsson is fighting fit. With news like that, it might be tempting to hold on for some more upside. But don't. Good news has its boundaries.

Ericsson posted second-quarter earnings equivalent to $711 million. Sales rose 18% from a year ago to $4.3 billion. The Swedish telecom giant said its gross profit margins surged to 47% from 35% a year earlier, showing the dramatic impact of its cost-cutting program.

Cost cutting can go only so far, however. To keep up those great big margins, now at an all-time high, Ericsson will need to boost sales. But quarter on quarter, Ericsson's orders were flat, suggesting that big telecom customers are getting more tight-fisted when it comes to buying the firm's 3G network technology. Indeed, Ericsson cautions that underlying market growth in dollar terms this year is likely to be just moderate.

Besides, a lot of Ericsson's sales will come from emerging markets, especially China and India, where it's bound to face stiff competition from Lucent (NYSE: LU  ) and Nortel (NYSE: NT  ) and from low-cost players such as Huawei Technologies.

Back in April, I reckoned that Ericsson, lean and mean, could sustain its margins. I'm less confident now. It's hard to get too excited about the company's stock trading at 22 times 2004 earnings. Ericsson shares have been stuck in the $25-$30 range. Expect them to stay there.

Fool contributor Ben McClure doesn't own shares of any companies mentioned in this article.


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