Here's Why You Should Capitalize on Alcatel-Lucent’s Pullback

Alcatel shares have lost some ground this year, but this is a good thing. Let’s see why.

Apr 23, 2014 at 12:15PM

Telecommunications and networking equipment company Alcatel-Lucent's (NYSE:ALU) turnaround has lost steam this year. The French company is down 15% in 2014, despite posting impressive fourth-quarter results in February. However, Alcatel can get back on track thanks to aggressive cost reductions and weakness at Cisco (NASDAQ:CSCO). Let's take a look why investors should consider taking advantage of the recent weakness in Alcatel's share price.

A terrific turnaround
Alcatel-Lucent is turning around impressively. It posted a net profit of $182 million in the fourth quarter, down from a loss of $2.11 billion last year. The company's gross margin improved amid aggressive cost cutting to clock 34% in the fourth quarter. In comparison, analysts had expected a gross margin of 32% and an adjusted net loss. 

Through the Shift Plan, Alcatel expects further improvements in 2015 by focusing on cash generation and profitable growth. Also, Alcatel has been making some moves to strengthen its balance sheet. It has now restructured its debt to a large extent, while sales of non-core assets are also helping the company bolster the balance sheet.

Opportunities in the end-market
Alcatel is also targeting different growth areas such as network and cloud infrastructure. These two areas are interrelated, with networking in data centers becoming a key part of the infrastructure nowadays. Alcatel is looking to make the most of this market through its carrier-grade IP routing solutions. Next, the demand for ultra-broadband access is rising due to the proliferation of devices such as smartphones, tablets, and other connected devices. This is giving rise to more demand for networking equipment, opening up opportunity for Alcatel to grow its business.

On the other hand, Alcatel is seeing good growth in fiber and LTE technologies. These services are being adopted by both telcos and cable providers. Moreover, the adoption of passive optical networks by cable providers is also an encouraging factor since this market is expected to grow at a compounded annual growth rate of 3.56% until 2018, according to analysts.

Alcatel's IP routing business is also gaining steam, primarily driven by increasing capacity requirements in mobile networks with large LTE rollouts across the globe. This has enabled Alcatel to strengthen its position in edge routing and mobile backhaul. According to management, Alcatel is entering a new phase of expansion, led by ever-increasing capacity requirements and IP transformations.

Going forward, Alcatel is also looking to tap the market for software-defined networking, or SDN, through its Nuage venture. Nuage is aiming to develop an open, software-based solution to address key data center network constraints that limit cloud service adoption. A year ago, Nuage started pilot projects in Europe and North America, and so far it has done well by recording three commercial contracts. 

Alcatel also enjoys a solid position in terrestrial optics with its 1830 PSS solution present in 44 of the top 50 service providers worldwide. Further, Verizon has selected the Alcatel-Lucent 1830 Photonic Service Switch as a key element in its continuing move to an all-IP optical network for the U.S. 

Cisco's weakness is an advantage
Alcatel will be helped by Cisco's woes in the networking equipment industry. Cisco's struggles in emerging markets have continued after the NSA spying allegations last year. The networking company saw a strong decline of 12% in orders from emerging regions. Brazil and Russia were the biggest points of concern for Cisco, with orders from these countries dropping 25% and 30%, respectively. 

Moreover, Cisco expects growth in its core networking business to slow down, which is in stark contrast to Alcatel. The French company's core networking operating income more than tripled in the last fiscal year. Due to strength in both IP transport and the IP platform, Alcatel expects this trend to carry on in the future.

Bottom line
Alcatel's performance has not been sprightly this year. However, the company's underlying business is moving in the right direction and it is targeting meaningful improvements by 2015. So, you should consider capitalizing on the weakness in Alcatel's share price and consider adding more shares to their portfolio.

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Mukesh Baghel has no position in any stocks mentioned. The Motley Fool recommends Cisco Systems. 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.

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