JDSU's Results Highlight The Volatility Of The Telco Capex Recovery

By Stephen D. Simpson, CFA | August 15, 2013 AAA

Happy days are here again in the telecom capex market, right? After all, companies like Juniper (Nasdaq:JNPR), Ciena (Nasdaq:CIEN), and Finisar (Nasdaq:FNSR) have seen their stocks shoot up over the last three months, and even Alcatel-Lucent (NYSE:ALU) is looking viable again. Certainly if Alcatel looks like it could make it, the market must be improving, right?

Well, yes and no. Spending is still lumpy and idiosyncratic, and there are gaps between what companies are saying about orders (and what analysts/investors are projecting for 2013/2014) and what's actually happening in the here and now. And that's where JDSU's (Nasdaq:JDSU) earnings come into play – JDSU didn't have a bad quarter and management sounds optimistic about the recovery, but the actual business still needs time to come around. Of course, those investors who think they can just wait until they see the recovery in the financials before they buy the shares may well find that most of the gains have already gone to others by then.

Fiscal Q4 Results – This Isn't Quite What A Recovery Should Look Like
JDSU reported that revenue fell 3% from the year-ago quarter (about 2% below expectations) and rose about 4% sequentially. There was weakness across the business, as the Test business saw a 3% decline (but a 9% sequential improvement), Optical Products fell almost 2%, and Security/Performance revenue fell 7%.

Margins were a mixed bag as well. Gross margin improved nicely, rising almost half a point from last year and nearly four points sequentially. The year-ago operating profit reversed to a loss, though, and segment income likewise fell 20%, with a sizable decline (30%) in Test and a more modest decline in Security/Performance (12%) offsetting 16% growth in Optical Products profits.

SEE: Analyzing Corporate Profit Margins

Business Should Get Better, But When?
By the standards of tech stock “miss and maintain” quarters, JDSU is getting treated pretty gently by the market, with the shares up slightly as of this writing. Certainly investors had the opportunity to adjust their expectations going into this quarter.

In Test, even Danaher (NYSE:DHR) had an iffy quarter, while more telco/wireless-focused test and measurement companies like EXFO (Nasdaq:EXFO) and Ixia (Nasdaq:XXIA) had disappointing quarters. It appears as though Tier 1 carrier customers have been more aggressive in repurposing/reusing older equipment and holding off on new orders, and that likely doesn't bode well for Agilent's (NYSE:A) test and measurement business either (Agilent reports after the close Wednesday evening).

At the same time, I think expectations were relatively restrained for the Optical Products business. Ciena and Infinera (Nasdaq:INFN) appearing to be doing great with 100G, with others like Huawei are not doing as well and the overall optical systems market really hasn't recovered yet. To that end, I'm a little surprised that investors weren't more concerned with the relatively restrained sequential growth guidance (about 3%), as it seems like the second half rebound is going to be weaker than previously expected.

Can JDSU Achieve Everything It's Setting Out To Do?
I still have some concerns about whether JDSU management has spread itself too thin. Everything management has talked about doing, including growing the Test business (with a major focus on wireless), maintaining strong share in key components markets, and growing the fiber laser, gesture recognition and anti-counterfeiting businesses, makes sense. I'm just concerned that a modestly-sized company is trying to do too many significantly different things at once, and that there is a risk that balls are going to get dropped along the way.

SEE: How To Pick The Best Telecom Stocks

On the other hand, what's the alternative? Technologies/businesses like gesture recognition, fiber lasers, and anti-countefeiting all offer solid growth opportunities and markets where JDSU can carve out some real leadership. They also should help to offset the cyclicality/volatility of the telecom business, and that's a positive on balance.

The Bottom Line
Modeling a turnaround/recovery is tricky business. On the whole, I'm comfortable with my long-term estimates of 7% and 14% revenue and free cash flow growth, respectively. That said, I do acknowledge that the recovery could be stronger than I expect, which would pull more of the expected revenue and free cash flow forward into the closer years and increase the net value of those cash flows.

I would expect JDSU shares to rise from here as the telco equipment recovery gets its legs under it, but on balance I'd still prefer to own Ciena or maybe Finisar over JDSU.

Disclosure: At the time of writing, the author did not own shares of any company mentioned in this article.

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