Telecom gear maker ADTRAN (NASDAQ:ADTN) has defied all odds this year. Despite a decline in revenue and margin, the stock has seen a decent gain of 38% on the back of optimism among investors that its business will improve.
ADTRAN has sent out positive signs ever since it reported a surprisingly strong first quarter six months ago and followed it up with another better-than-expected second quarter. However, a stock trading at almost 54 times earnings needs to show growth and ADTRAN has done just the opposite so far as seen here.
A mixed performance in the cards
With the company's third-quarter report set to be released soon, ADTRAN will once again need to convince investors that its business is indeed improving. Analysts expect the company to report earnings of $0.22 a share on revenue of $175 million.
ADTRAN might satisfy the revenue estimate. It had guided for a sequential revenue improvement of mid to high single-digit percentage points last time; this translates into an expected $173 million plus in revenue. Non-GAAP EPS was $0.21 in the second quarter. Since ADTRAN is expecting gross margins to decline to the mid to high 40s range in the third quarter from 49.2% in the previous one, earnings might decline sequentially and miss estimates.
Guidance is the key...once again
ADTRAN's guidance will once again assume great importance. And, once again, management may provide positive commentary given the developments in the telecom industry and the company's recent design wins. In the second quarter, ADTRAN's enterprise product was selected by a Tier 1 carrier in Europe, probably Deutsche Telekom, with the contract expected to be worth around $1 billion.
In addition, ADTRAN had claimed that the company is in a good position to benefit from network upgrades by a couple of its key customers in the U.S. and Europe. ADTRAN management had also stated that the company will start seeing higher revenue from an important customer in the U.S., probably AT&T (NYSE:T), next year.
ADTRAN believes that the company is in the early stages of an upgrade cycle, and this sounds identical to what other players in the industry, such as Ciena (NYSE:CIEN), said last month. Ciena saw higher orders in the previous quarter and achieved a record backlog. The company landed design wins at several international Tier 1 customers and anticipates that they'll start spending in the ongoing quarter.
Ciena's order growth in the previous quarter was better than its sequential revenue growth and the company was able to guide better than Street estimates. The reason behind Ciena's strong performance so far this year can be traced to its client list that includes the likes of AT&T and Verizon.
AT&T has been busy rolling out its 4G LTE network at a brisk pace. Ma Bell's LTE network currently covers around 350 markets. Going forward, the company intends to cover 300 million people by its 4G network by the end of next year. This move will bring AT&T closer to Verizon's network coverage, which is already present across 500 markets and covers 300 million people. In addition, AT&T is concurrently adding 40,000 small cells in urban locations through Project Velocity IP to improve network efficiency.
Now, since AT&T is also an ADTRAN customer, the telecom carrier's network deployment and focus on improving efficiency bodes well for it. In addition, ADTRAN had expanded its channel of value-added resellers in the previous quarter as it looks to make the most of the positive telco spending environment.
The bottom line
As previously mentioned, ADTRAN has been sending out positive signals such as market share gains at Tier 2 carriers, an improving enterprise business, and increasing strength in its European business. Management's bright outlook has propelled the stock close to its 52-week highs and has stretched its valuation in the process.
There's a chance of the company missing estimates when it reports results, but given the strength in the end market, it might be able to deliver a satisfying outlook. But, with a trailing P/E of 54, investors need to tread cautiously and consider buying ADTRAN only on sharp pullbacks.
Harsh Chauhan 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.