Shares of Ciena (NASDAQ: CIEN ) , the network specialist, have soared as much as 20% since the company reported its fiscal first-quarter earnings, which beat both top- and bottom-line estimates. Although this company has had a tough 2012 due to an abysmal carrier spending environment, it's beginning to look as if Ciena is on its way to back to posting solid results.
Nevertheless, this stock and that of other telecoms are tough to evaluate without knowing for certain if the likes of AT&T and Verizon are going to remain tight with their budgets. But solely on the merit of Ciena's performance, investors have good reason to be optimistic that a recovery may not be too far away. And this stock may still have room to run.
Nice rebound from a down fourth quarter
Ciena didn't have a strong end to fiscal 2012. Not only did revenue fall short of expectations, but the company also lowered guidance. Plus, when you consider the recent subpar earnings results from other carrier-dependent companies like Juniper (NYSE: JNPR ) , not a whole lot was expected from Ciena.
Nevertheless, the company still managed to log $453.1 million in revenue, which was an increase of 9% year over year. The packet networking segment (formerly CESD), which consists of the company's top-selling 3000 series routers, arrived strong for second consecutive quarter, generating $46 million in revenue. That a 114% jump from the $21.5 million the segment posted a year ago.
Management seems really excited about the direction of the overall Ethernet services business. That said, I think it behooves Ciena to try to incorporate more of the networking segment into its business. The company seems committed to that task, but such a strong business should account for (at least) more than 10% of the total revenue. That said, the 10% doubles what the segment provided a year ago, so management is working that segment in.
Conversely, management seems to be phasing out the optical transport business, which now accounts for just 12.7% of total revenue, or half of what it was a year ago. Revenue in that business has eroded for the past five quarters and has decreased 46% year over year. That's not a concern, however. There seems to be some give-and-take with the Ethernet business.
Plus, management did say that part of the revenue decline in the optical transport business has had to do with its recent segmentation change, which removed certain types of hardware out of one segment and placed into another. So essentially, customers are being recategorized.
Solid execution's paying dividends
I don't think Ciena's management is often credited enough for its execution. Profitability showed this team has a solid pulse on its business. Gross margin advanced 3% year over year and 2% sequentially. The company has been pushing its converged packet switching and software business very effectively. This is important since they impact the bottom line at a greater rate.
Likewise, there was a 6.3% improvement in operating margin, which also advanced 3.5% sequentially, helped by operating efficiencies that management has discussed in prior quarters. That contributed to lower-than-expected operating expenses, which arrived at $177 million.
What of the competition?
It's great to have solid management team steering the ship, but so does Cisco (NASDAQ: CSCO ) , which is in the midst of a significant turnaround of its own. Granted, these two are not often considered direct competitors per se, but Cisco is also waiting to pounce on any sign of recovery in carrier spending. Although Cisco has begun to (somewhat) phase out its hardware businesses in favor of software, Cisco's switches still dominate network enterprises.
Besides, Cisco's not just going to surrender that business. And if Cisco has a change of heart, Ciena can begin to see some margin pressure. That said, Ciena should continue to outperform Juniper, which seems to have lost some of its fight after rumors surfaced that it tried unsuccessfully to sell off some assets -- presumably to Cisco. But Juniper just reported a 9% increase in service provider revenue, so all may not be lost since it just may have signaled that carriers are becoming more optimistic.
What of the stock?
I'm having a hard time with the valuation at current levels. It's great for Ciena's shareholders that the Street loved the earnings report. But a 20% jump in a week is a bit overzealous. And it indicates that perhaps the Street has already priced in a full recovery. I don't think investors can know the extent of a recovery for at least a couple more quarters. But so long as Ciena's margins continue to improve, the risk is palatable.