I'll often get emails from readers that ask me "if you think this stock is cheap, why don't you own it?" Adtran (Nasdaq:ADTN) is a great example of why I often wait to pull the trigger - while I do like the company's management and I think there's potential for the business to grow, no single boat can fight the tide and I'd rather wait to see signs of stabilization (or recovery) in the carrier spending market before stepping up with my own money.

Investopedia Broker Guides: Enhance your trading with the tools from today's top online brokers.

Disappointing Q2 Results
Adtran seemed cautiously optimistic about a carrier spending recovery coming out of the first quarter, but it looks like that rebound really didn't materialize.

Revenue fell very slightly on a year-on-year basis, while rising nearly 37% sequentially. That translated into about a 3% miss relative to sell-side estimates. On an organic basis, though, growth was not quite as good - revenue fell about 2% from last year and rose 20% from the first quarter.

SEE: How To Decode A Company's Earnings Reports

Within revenue, carrier spending jumped 13% due in part to the acquisition of Nokia Siemens Networks' broadband assets. Broadband access (which is nearly half of the company's revenue base) saw 8% annual growth and 69% growth from the first quarter, as the company enjoyed a good rebound at customers like CenturyLink (NYSE:CTL) and Telmex. Legacy product sales (like HDSL) were weaker though, as it seems that major Tier 1 customers like Verizon (NYSE:VZ) are de-prioritizing spending here.

Adtran is also struggling to show solid operating leverage. Gross margin fell more than six points from last year and more than three points from the prior quarter. Management continues to support its sales efforts, though, and devote considerable resources to research and development. As a result, operating income fell sharply from last year's level.

SEE: Zooming In On Operating Income

A Disappointing Outlook Looks Like an Industry Problem
As is often the case, investors were more concerned with Adtran's guidance than the actual reported results. Whereas the Street had been hoping for 16% sequential revenue growth in the third quarter, management is now looking for flat to slightly positive performance.

That's a pretty sharp revision. If there's good news, it's that companies like Acme Packet (Nasdaq:APKT) and Calix (Nasdaq:CALX) have also disappointed investors quite recently - suggesting that it's an industry problem, as top carriers still haven't increased their spending as hoped. Still, knowing that it's a widespread problem is pretty cold comfort, and investors can't be feeling too optimistic about other players like Alcatel Lucent (NYSE:ALU), Ciena (Nasdaq:CIEN), Tellabs (Nasdaq:TLAB) and Juniper (Nasdaq:JNPR) right now.

The Bottom Line
In my mind, the biggest long-term risk in the Adtran story is the company's strategic focus on being a low-cost supplier to mature markets and largely giving a pass to new emerging growth markets (until they mature). That sounds a lot like the slower-growth cash farming that lures many value-oriented investors into stocks that stagnate for long stretches because they can't feed the Street's lust for tech growth.

SEE: How To Make A Winning Long-Term Stock Pick

Still, I like the last-mile business at Adtran, as well as the prospects for the BlueSocket WiFi access business and the longer-term derivative plays on video-driven IP growth. However, aggressive competition from companies such as Huawei or rejuvenated efforts at Ciena or Tellabs could seriously crimp the growth.

I'm slashing back my forward growth assumptions pretty significantly; estimating future revenue growth in the mid-single digits and a free cash flow conversion margin well below past levels. That translates into low single-digit free cash flow growth over the next 5-10 years, but even with that low growth rate, these shares seem to have a fair value above $30. As I said in the first paragraph, I'd be seriously tempted to wait before buying these shares, but it's hard to ignore the potential value that may be emerging here.

Disclosure: Telmex is a subsidiary of America Movil (AMX), a stock the author has owned since December of 2004.

Related Articles
  1. Stock Analysis

    What Seagate Gains by Acquiring Dot Hill Systems

    Examine the Seagate acquisition of Dot Hill Systems, and learn what Seagate is looking to gain by acquiring Dot Hill's software technology.
  2. Stock Analysis

    What Will HP's Split Do to Its Stock?

    Read about Hewlett-Packard Enterprises, a new spinoff company from Hewlett-Packard. Understand how the two companies will focus on different markets.
  3. Investing Basics

    Learn How to Trade Semiconductor Stocks in 4 Steps

    The enormously diverse semiconductor industry requires market players looking for exposure have specialized knowledge.
  4. Mutual Funds & ETFs

    What Exactly Are Arbitrage Mutual Funds?

    Learn about arbitrage funds and how this type of investment generates profits by taking advantage of price differentials between the cash and futures markets.
  5. Investing News

    Ferrari’s IPO: Ready to Roll or Poor Timing?

    Will Ferrari's shares move fast off the line only to sputter later?
  6. Investing News

    Why the Philippines Is the #1 Source for Tech Startups & Talent

    In the last few years, the Philippines has been working diligently to re-invent itself, and that work has paid off. The Southeast Asian nation is rapidly gaining notoriety as a leading source ...
  7. Investing News

    Austin Set to Rival Silicon Valley

    Over the years, Austin, Texas has lovingly embraced its quirky reputation with the slogan “Keep Austin Weird.” Today, the capital city is attracting several tech startups and investors, making ...
  8. Stock Analysis

    5 Cheap Dividend Stocks for a Bear Market

    Here are five stocks that pay safe dividends and should be at least somewhat resilient to a bear market.
  9. Stock Analysis

    The Biggest Risks of Investing in Amazon Stock

    Find out which risks are most important to Amazon's shareholders. Learn which operational risks impact share prices and which financial risks affect investors.
  10. Investing

    How to Win More by Losing Less in Today’s Markets

    The further you fall, the harder it is to climb back up. It’s a universal truth that is painfully apparent in the investing world.
  1. Can working capital be too high?

    A company's working capital ratio can be too high in the sense that an excessively high ratio is generally considered an ... Read Full Answer >>
  2. How do I use discounted cash flow (DCF) to value stock?

    Discounted cash flow (DCF) analysis can be a very helpful tool for analysts and investors in equity valuation. It provides ... Read Full Answer >>
  3. How do dividends affect retained earnings?

    When a company issues a cash dividend to its shareholders, the retained earnings listed on the balance sheet are reduced ... Read Full Answer >>
  4. What is the formula for calculating compound annual growth rate (CAGR) in Excel?

    The compound annual growth rate, or CAGR for short, measures the return on an investment over a certain period of time. Below ... Read Full Answer >>
  5. What is the difference between called-up share capital and paid-up share capital?

    The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
  6. When does the fixed charge coverage ratio suggest that a company should stop borrowing ...

    Since the fixed charge coverage ratio indicates the number of times a company is capable of making its fixed charge payments ... Read Full Answer >>

You May Also Like

Trading Center
You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!