Shares of Sierra Wireless (NASDAQ:SWIR) have skyrocketed nearly 70% so far in 2017, including a 29% single-day pop in February after the Internet of Things specialist impressed Wall Street with its strong fourth-quarter 2016 results. But last week, Sierra Wireless declined 7% after one analyst went out on a limb to downgrade the stock.
That raises the question: Should Sierra Wireless shareholders be concerned? I don't think so.
The "downgrade" that wasn't
For perspective, last week's downgrade came from Raymond James analyst Steven Li, who reduced his rating on Sierra Wireless stock from "outperform" to "market perform." At the same time, however, Li also increased his price target on Sierra Wireless from $23.50 to $30.00 per share. But while that was roughly the same price at which Sierra Wireless stood just prior to the downgrade, Li's target represents a roughly 14% premium to Sierra Wireless' closing price of $26.30 per share on Monday.
To explain his stance, Li pointed to uncertainty surrounding the margins of Sierra Wireless' newer high-volume contract wins, notably including its second win in its 4G-connected-car program with Volkswagen, announced last quarter.
"We don't have much visibility regarding the profitability of these larger contracts," Li said, according to the Financial Post. He elaborated: "They also carry some gross margin risks and depending on where the margins end up, some (or all of it) may already be priced in current estimates."
On finding balanced growth
To be fair, it's clear Li has been mulling these margin concerns since Sierra Wireless' report in February. During the company's subsequent conference call with analysts on Feb. 9, he directly asked management whether these "elephant-size" deals will put pressure on gross margins.
Sierra Wireless CEO Jason Cohenour responded:
Clearly when an elephant like Volkswagen comes to market in late 2018 and through 2019, that's a very high-volume program which will, I predict, have a dampening effect on overall gross margin. Now between now and then, we are launching high-volume programs. [...] Just be careful not to overheat expectations given unusually strong short-term gross-margin-percentage performance here, because there are moving pieces.
Cohenour went on to note the company will continue to be "vigilant" both in managing its cost of goods sold, and in driving revenue growth from its high-margin businesses faster than that of the overall business.
"But you also can't ignore that there's growth opportunities in the high-volume OEM customers as well," Cohenour said, "And as those come into the mix, that will have a counterbalancing effect."
The bottom line
In short, Li's caution is fair. But Sierra Wireless still enjoys the enviable "problem" right now of finding the right balance between its lower-margin, high-volume contract wins and its higher-margin, lower-volume deals. If the latter revenue stream continues to grow at a faster pace than overall revenue -- and keeping in mind that lower-volume deals tend to be less predictable in these early stages -- Sierra Wireless should be able to maintain its attractive margin profile even as it continues to land more whales in the coming years.
Either way, Sierra Wireless should continue to play a central role in the burgeoning Internet of Things market. That doesn't mean there won't be pullbacks along the way. But I'm convinced that patient long-term Sierra Wireless investors have nothing to worry about.