This Telecom Equipment Maker Is Down, But Not Out

A transition in carrier spending has hurt this telecom equipment maker, but it can bounce back.

Jul 10, 2014 at 10:00PM

Telecom equipment maker ADTRAN (NASDAQ:ADTN) is down 14% so far this year, as declining enterprise sales have weighed on the company's results. Carrier enterprise spending is in transition mode due to the Federal Communications Commission's Connect America Fund, or CAF, initiative. This has led to a drop in carrier spending for the time being. As a result, ADTRAN missed the Street's first-quarter revenue guidance. 

ADTRAN's prospects, however, look strong. Clients such as AT&T (NYSE:T) and CenturyLink (NYSE:CTL) should help ADTRAN improve its performance going forward, as they are spending aggressively on network expansion.  The company is already seeing momentum in some of its businesses, and strength in carrier spending will help it come out of its slump.

Positive indicators
The company's broadband access segment was up 13% year over year in the first quarter, driven by a robust performance from its international business. ADTRAN witnessed strong shipments in fiber to the node, with products such as vectored very-high-bit-rate digital subscriber line, or VDSL, VDSL2, and gigabit passive optical network, or GPON, gaining traction. 

It also saw strong momentum in carrier Ethernet, along with Ethernet switching, for the Internet working product category. Shipments of ADTRAN's OPTI-6100 products increased in the quarter, which is a sign of revival in carrier spending. ADTRAN's value-added reseller channel also added approximately 70 new partners to its dealer base.

According to ADTRAN, the transition to the new CAF will be beneficial for its business as carriers eventually adjust to the new rulings. The enhanced funding for CAF phase-2, and its eventual implementation, will bolster the company's customer base. The company believes that CAF will provide additional incentive for carriers to upgrade their infrastructure and, as a result, ADTRAN should see an increase in carrier spending.

End-market improvements
The company believes that its products and geographic diversification are well-timed with the carrier cycle associated with the rollout of ultra-high-speed access. There's an accelerated adoption of next-generation access technologies by carriers around the world to strengthen their competitive positions and meet increasing customer demand.

For example, AT&T and CenturyLink are upgrading their networks to stay competitive, and both are ADTRAN clients. 

AT&T is preparing to build out a fiber optic network under its Project Velocity IP initiative. The telecom giant recently announced a plan to expand its ultra-fast fiber network to approximately 100 cities and municipalities across the U.S. AT&T will cover 21 new metropolitan areas with its fiber network as it tries to nip competition from Google in the bud. The search giant is also busy rolling out its fiber network in select locations. AT&T intends to deliver broadband speeds of up to 1 Gigabit per second, and as it builds out the fiber network by investing in infrastructure, ADTRAN's prospects will improve. 

CenturyLink is also expanding its GPON, along with deployment of fiber to commercial buildings. It is trying to deliver fast Ethernet-quality speeds to customers with GPON, enabling them boost their businesses with better cloud facilities. Meanwhile, the deployment of fiber for wireless towers by CenturyLink will result in increased demand from wireless carriers for data backhaul, leading to additional business opportunities for ADTRAN.

CenturyLink is also deploying its advanced cloud node to six data centers. It will complete this exercise by the end of the year, thereby boosting demand for ADTRAN's nodes.

The bottom line
ADTRAN has struggled this year. As a result, the stock has become cheap in terms of valuation, with a forward P/E ratio of 17. It also has a PEG ratio of 0.87, indicating undervaluation and earnings growth.  Analysts also hold a similar opinion, and according to Yahoo! Finance estimates, ADTRAN's earnings are expected to grow at an annual rate of almost 25% for the next five years. The stock might be trading lower this year, but a closer look at its business and valuation indicates that it could be a good buy on the drop.

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Sharda Sharma has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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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