Hardware companies are vying to be winners of the future data economy, powered by 5G, cloud computing, and the Internet of Things (IoT). If you as an investor can separate the wheat from the chaff, you could come out a big winner. Two such hardware companies are Arista Networks (NYSE:ANET) and Sierra Wireless (NASDAQ:SWIR).
Arista Networks makes cloud data center switches. Its disruptive platform uses merchant silicon (off the shelf chips produced by third parties) tied together via Arista's EOS operating system. EOS plus merchant silicon allows data center operators to run Arista's switches in a flexible, low-cost fashion, making Arista a preferred vendor to fill cloud data centers. Recently, Arista has expanded into campus networking and into routers as well.
Sierra Wireless makes IoT-related modules, gateways, modems, sensors, and software for connected devices. Sierra's products go into connected automobiles, mobile devices, networking devices, and "smart" industrial equipment.
If you are going to pick the company with the better earnings momentum, the clear winner is Arista.
Arista trounced Sierra Wireless' growth in 2018, as revenue rose nearly 31% vs. Sierra's mere 14.9% growth rate. In addition, Arista was solidly profitable, with a net profit margin of 15.3%, whereas Sierra lost money in 2018, with negative (3.1%) net margins.
However, both companies booked several nonrecurring charges. Arista Networks settled a patent dispute with Cisco (NASDAQ:CSCO), in which it had to pay the switching giant $405 million in 2018. Without that charge and other GAAP charges, Arista's non-GAAP net income margin was nearly 30%, up a whopping 45.3% over 2017.
Sierra Wireless, on the other hand, incurred several special charges in 2018, but not for the same reasons. It's fallen on hard times, suffering weakness across its main auto business and a loss of market share among mobile and networking solutions. So, new CEO Kent Thexton is restructuring the business, which means layoffs, writedowns, and asset disposals.
In 2018, the company took over $22 million in charges related to acquisitions, restructuring costs, a loss on the sale of its iTank business, and various other "nonrecurring" charges. Without these various charges, the company's non-GAAP net margin was a more respectable 16.1%.
That's certainly better than losses, but doesn't come close to Arista's momentum and profitability.
What 2019 has in store for each
Looking ahead to this year, things appear to be steady as she goes for Arista, but they're taking a turn for the worse for Sierra. Sierra's guidance calls only for flat revenue in 2019, with a rather steep decline in non-GAAP earnings per share (EPS), from the $0.90 posted last year to just $0.30 per share in 2019. The company has run into problems with some core segments and is investing in new solutions for 5G connectivity and LPWA (low-power wide area network) modules. Those applications have large opportunities ahead of them, but the payoff is still a ways away, and it's an open question as to whether Sierra will win over competitors.
While Arista doesn't give full-year guidance, the company did forecast roughly 25.5% revenue growth next quarter, as well as continued great margins. Arista continues to benefit from its low-cost advantage and flexibility versus larger rivals such as Cisco, and its products are indispensable to the multiyear buildout of global cloud infrastructures, as well as the need for faster and improved networking capabilities.
In other words, Arista appears to enjoy quite the formidable competitive advantage and a less cyclical business, while Sierra Wireless, though offering leading products, appears to be under more competitive pressures and is more sensitive to business cycles in areas like automobiles and PCs.
As you can imagine, this puts Arista in a much more favorable spot.
Of course, valuation also plays into one's decision. On that front, Arista is much more expensive -- the company trades at 28.8 times its 2020 non-GAAP earnings estimates, while Sierra Wireless trades at only around 15.7 times 2020 estimates -- obviously, much cheaper.
However, analysts' 2020 EPS estimate of $0.77 for Sierra (see the chart below) assumes a rebound from the company's own 2019 EPS estimate of just $0.30. So, while Sierra is no doubt the cheaper stock, one still needs to be confident it can turn the ship around, and it might take a year or more to find out whether Thexton's prescription is working.
Growth or value?
For those willing to bet on turnaround situations, Sierra Wireless could be the superior pick. If Thexton's plans work out, Sierra's beaten-down stock could surge much higher. However, in the current market environment, high-quality growth stocks with more predictable results seem to be winning the day. With its top-notch management, low-cost advantage, and consistent growth, I still believe Arista is the better play in 2019.