Ericsson (NASDAQ:ERICY) offers yet another hopeful sign that the telecom industry is returning from the dead. The telecom equipment giant's first-quarter figures, like those from peersMotorola (NYSE:MOT) and Qualcomm (NASDAQ:QCOM), blew the doors off analysts' predictions. But Fools take note: The turnaround is already built into Ericsson's share price.
In its usually weak first quarter, Ericsson returned to a net profit and pumped out sales equivalent to $3.63 billion, an 8.5% year-on-year increase. Even better, the Swedish big hitter drove home a whopping gross margin of 44.7%. That's more than 10% above first-quarter 2003 gross margins and 4% above the fourth quarter. That kind of profitability exceeds even that seen back in Ericsson's heyday in 1999.
Sustaining those margins is not impossible. Ericsson is now a lean company, and thanks to a fruitful alliance with Sony (NYSE:SNE), it no longer has to beef up its handset business alone. Meanwhile, Ericsson is enjoying growing demand, especially in its area of strength -- hardware for wireless networks. A hearty congratulations should go to Ericsson's cost-conscious CEO, Carl-Henric Svanberg, for successfully revamping the business.
Competition from players Nortel Networks (NYSE:NT) and Nokia (NYSE:NOK) will surely become fiercer. But the biggest problem is that Ericsson's price, up 80% already in 2004, looks like a lofty valuation, even if the company can sustain those great big margins. Predicting the spending habits of big telecom service companies such as SBC Communications (NYSE:SBC), Verizon (NYSE:VZ), and Vodafone (NYSE:VOD) is a risky game, and the outlook for third-generation "3G" wireless technology remains hazy. Assuming anything less than a huge overnight uptake in the latest 3G technology, the shares are selling out of whack with free cash flow. Ericsson now trades on a hefty enterprise value-to-free cash flow multiple of 27. Despite the strong first-quarter results, it doesn't look like a good bet here.
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Fool contributor Ben McClure doesn't own shares of any of the companies mentioned in this article.
