Every day, Wall Street analysts upgrade some stocks, downgrade others, and "initiate coverage" on a few more. But do these analysts even know what they're talking about? Today, we're taking one high-profile Wall Street pick and putting it under the microscope...
In less than 24 hours, Ciena Corporation (NYSE:CIEN) will report its fiscal Q3 results. Wall Street can hardly wait to see them.
Curiously for a company whose news is not yet even out yet, three big Wall Street analysts have already jumped the gun and published positive notes on Ciena ahead of earnings. Tic-tac-toe, three in a row, Citigroup, UBS, and MKM Partners are all recommending that investors buy Ciena stock before earnings. Here's why.
1. MKM tries to superglue its crystal ball back together
MKM led off the prognosticators with a note yesterday predicting "strong results" out of Ciena in Q3, and further stating the company will "provide good Q4 guidance" tomorrow. MKM bases its prediction on "checks" of how the company's orders are stacking up among customers, and says Ciena's business appears to have improved since last quarter, when sales were up only 10%.
Now admittedly, the last time MKM made a prediction like this one (on Feb. 21, ahead of the company's March 8 Q1 earnings report), Ciena stock proceeded to crash, losing 18% of its market cap over the course of the next month. Fortunately for investors, this time around it's not just MKM singing Ciena's praises.
2. Citi chimes in
The really big news today is that Ciena now has a fan in Citigroup, which this morning clambered out on a limb to upgrade the stock to buy just hours before earnings. As explained on TheFly.com, Citi acknowledges a risk that Ciena may suffer from "near-term weakness in Telco spending." But Ciena is having more success getting its optical networking equipment incorporated into data centers (i.e., server farms) and winning share in that market.
With data center sales expected to "pick up in 2018," investors will be looking for guidance from Ciena to support that view in tomorrow's report. Citi thinks the evidence will be there, and urges investors to buy before earnings, rather than wait to see the prediction confirmed (by which time Ciena stock may already have gone up).
And Citi has a $29 price target on Ciena shares, indicating it thinks the shares could go up quite a lot -- as much as 19% over the next 12 months.
3. UBS spots a clue
Last but not least, a few hours after Citi made its upgrade, Swiss megabanker UBS reiterated its own buy rating on Ciena. Echoing Citi's concerns about "Tier-1 spending softness," UBS nonetheless said it sees the "risk/reward" ratio as "attractive" for Ciena stock.
The analyst also highlighted Ciena's "shareholder friendly move" of announcing a convertible debt exchange last month. Instead of allowing debtholders to trade in their 3.75% convertible notes for Ciena shares (which would be a good deal if those shares were overpriced), Ciena is trying to hang onto its stock, and encouraging debtholders to trade in their notes for more notes, plus a cash incentive.
Ciena's move suggests it thinks its stock is more valuable than its cash -- which not coincidentally, is also what the analysts are saying when they rate Ciena stock a buy.
The most important thing: Valuing Ciena
Is Ciena stock as cheap as the company -- and the analysts who follow it -- believe it to be?
Priced at nearly 33 times earnings, you might not think so. But here's something to keep in mind. In a note on StreetInsider.com (requires subscription), Citigroup pointed out that Ciena's high-margin software sales are becoming a bigger part of its business (relative to lower-margin hardware sales). As this trend continues over time, Citi believes Ciena could approach a long-term target of earning 15% operating profit margins on its sales.
Over the past five years, S&P Global Market Intelligence data show that Ciena has already successfully expanded its operating profit margin from negative levels all the way up to 7.6% today -- so far, so good. And if Ciena succeeds in reaching 15%, this implies a doubling of operating profit per sales dollar booked, and a halving of the stock's P/E.
The closer Ciena gets to its goal, the cheaper the stock will appear -- and the more likely it will be that these Wall Street analysts are right to recommend it.