Is telco the new housing? While no one outside the investing world would get particularly excited by that question, it is a subject of real relevance to us. I make the parallel because housing related stocks did very well in 2012 as they quietly priced in better conditions while climbing a wall of worry over the industry. I think telco could do the same this year. The early signs are good and looking at Ciena Corporation (NASDAQ:CIEN)’s numbers and other recent earnings in the industry, it appears that conditions are getting better.
What the Industry is Saying
Just as with housing last year, I am determined to prove an obsessive compulsive. Plenty of commentators have been looking for better signs from telco spending and the obvious place to start would be with the Tier 1 carriers. To be fair, a quick appraisal of their spending plans would not reveal any significant hike with their overall spending patterns. But the devil is in the details, there are clear that signs that areas like 4G/LTE, wireless, high speed Ethernet, Voice over LTE (VoLTE), network convergence and next generation networking will be strong from the Tier 1 market.
Initiatives like AT&T Inc. (NYSE:T)’s Project VIP are intended to expand LTE coverage to hundreds of millions of people by 2014. AT&T currently feels that it doesn’t need to ramp up LTE spending us much as it had previously intended but with its smart phone sales expanding rapidly there will be no option but to increase network spending. It is a slightly different story with Verizon Communications Inc. (NYSE:VZ), which has already aggressively rolled out its LTE network. Indeed, it sees spending as flat without any addition to its 3G network. However, it too is seeing much better than expected smart phone sales. The pressure to spend is building up.
Indeed, Cisco Systems, Inc. (NASDAQ:CSCO) recent results were testimony to improving trends, at least within the corporate side. It saw US enterprise spending up strongly and investors should appreciate that Cisco has a large part of its revenues within the Government sector. Indeed, it is forecasting switching revenues to be flat for the next two quarters. I suspect this is a combination of weak Government revenues and its exposure to legacy technologies.
Looking outside the Tier 1 North American carriers there is a lot of evidence to suggest that 2012 was a weak spending environment in legacy technologies for global carriers. My sense of what is going on is that a number of carriers have reacted to uncertain macro-conditions by slowing capital expenditures, but that consumer trends will force them to start spending on next generation technologies.
Ciena Corporation (NASDAQ:CIEN) is Well Placed
All of which leads me back to Ciena. The company is well placed in 100G networking and network convergence, so if the theory is correct than it should be seeing some early signs of a pick-up in demand.
For once the theory does appear to be correct!
Indeed, Ciena Corporation (NASDAQ:CIEN) now does 60% of its optical transport revenues from 40 and 100G. This is a good sign that carriers are jumping to higher speed Ethernet networking. In fact, Ciena talked of good demand for 100G technologies. With North America it is a story of its design wins starting to be deployed in line with some of the capital spending plans outlined above and Ciena Corporation (NASDAQ:CIEN)’s management spoke in optimistic tones about the upcoming year. Moreover, its switching revenues tend to be higher margin than transport so gross margins are expected to expand this year as the former becomes a larger part of the sales mix.
As for the order book, I think investors have cause for optimism. Ciena’s order book was back end loaded in Q1 (traditionally a weaker quarter for orders) which suggests that Q2 orders are in good shape. Indeed, its Q4 orders were at record levels and the positive tone around the results suggests that Ciena is set for a good year.
Where Next For Ciena Corporation (NASDAQ:CIEN)?
Ciena certainly isn’t a value stock but then I think we all know what happens with this sort of stock. The market seems to have a consistent tendency to buy growth stocks as long as the sector commentary is positive but then violently lose patience at the slightest sign of weakness. On a forward PE of 21x for 2014 the stock is hardly cheap and buying it requires a positive view of the macro outlook. On the other hand Ciena is exposed to the growth areas of telco spending.
On balance I think there are cheaper ways to play rising telco spending but if you want an aggressive play than Ciena Corporation (NASDAQ:CIEN) is well worth a look.
The article Why This Telco Is Well Placed for 2013 originally appeared on Fool.com and is written by Lee Samaha.
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