Using a 36-year old movie reference to introduce a tech stock ("Is it safe?" from "Marathon Man") may not be the best approach, but it's a worthwhile question to ask with Adtran (Nasdaq:ADTN). Adtran is an unusually high-quality company with solid share and good growth potential in "last mile access," but the company is critically dependent on carrier spending and that makes the timing of any recovery much harder to forecast.
Investopedia Broker Guides: Enhance your trading with the tools from today's top online brokers.

First Quarter Results Bad ... As Expected
Adtran made it pretty clear a month ago that carrier spending wasn't rebounding sharply in the first quarter, as the company preannounced a very disappointing quarter. Revenue fell 23% sequentially (and 19% from the prior year) and came in almost one-quarter below original expectations.

Revenue was pretty weak across the board - broadband access, Internetworking and optical access were all down sequentially, with broadband access down 33% sequentially. Management previously mentioned delayed buying activity from a major Tier 1 customer, which could mean CenturyLink (NYSE:CTL) or Frontier (Nasdaq:FTR), though it seems unlikely that AT&T (NYSE:T) was a big spender either.

With weak sales came negative operating leverage. Gross margin dropped almost five points from last year, while operating income fell by nearly two-thirds. Adtran management runs this business for the long-haul, and the company didn't cut sales or research and development spending in response to the weaker sales environment.

Are Things Finally Getting Better?
Management comments seem to indicate that carrier spending was getting better as the first quarter went on. Only time will tell. I think Adtran has a credible management team, but investors should certainly want to hear from companies like Juniper (NYSE:JNPR), Ciena (Nasdaq:CIEN), Acme Packet (Nasdaq:APKT) and Alcatel Lucent (NYSE:ALU) to get a fuller sense of the carrier demand environment. Of course, that takes time.

All in all, I think investors have reason to be guardedly optimistic. Carriers like AT&T, Verizon (NYSE:VZ) and Sprint (NYSE:S) really do have to spend on their networks eventually. The trouble is with the word "eventually" and how quickly that spending will pick up. Now, chip companies like ON Semiconductor (Nasdaq:ONNN) and Texas Instruments (Nasdaq:TXN) have sounded more optimistic about second-half communications demand, but it's not as though they really have a better insight on the markets than Adtran.

SEE: How To Pick The Best Telecom Stocks

How to Play the Rebound
Investors have a lot of different options for playing the carrier spending rebound. Investors who want big-risk/big-reward ideas could look at names like Ciena or even Powerwave (Nasdaq:PWAV), while names like Acme Packet and Juniper should also offer pretty good returns.

I do continue to like the Adtran story, though. I think the company's angles on last mile access, IP telephony and videos are legitimate and offer good growth potential. Moreover, the company seems to be getting traction overseas. Better still, the company has maintained reasonably good cash flow and returns despite some major declines in revenue.

The Bottom Line
Adtran's end market is cyclical and that has translated into cyclical free cash flow production as well. Consequently, 6 to 7% free cash flow growth over the next decade may sound ambitious and it's almost certainly not going to go in a straight line.

Nevertheless, I do believe these shares are undervalued and could climb well into the $30s on sustained evidence that carrier spending has resumed. There's still some downside risk to the story, but investors may finally have a relatively safe entry point.

Use the Investopedia Stock Simulator to trade the stocks mentioned in this stock analysis, risk free!

At the time of writing, Stephen Simpson did not own shares in any of the companies mentioned in this article.

Related Articles
  1. Personal Finance

    A Day in the Life of an Equity Research Analyst

    What does an equity research analyst do on an everyday basis?
  2. Mutual Funds & ETFs

    ETF Analysis: PowerShares S&P 500 Downside Hedged

    Find out about the PowerShares S&P 500 Downside Hedged ETF, and learn detailed information about characteristics, suitability and recommendations of it.
  3. Mutual Funds & ETFs

    ETF Analysis: ProShares Large Cap Core Plus

    Learn information about the ProShares Large Cap Core Plus ETF, and explore detailed analysis of its characteristics, suitability and recommendations.
  4. Mutual Funds & ETFs

    ETF Analysis: iShares Core Growth Allocation

    Find out about the iShares Core Growth Allocation Fund, and learn detailed information about its characteristics, suitability and recommendations.
  5. Mutual Funds & ETFs

    ETF Analysis: iShares MSCI USA Minimum Volatility

    Learn about the iShares MSCI USA Minimum Volatility exchange-traded fund, which invests in low-volatility equities traded on the U.S. stock market.
  6. Stock Analysis

    Should You Follow Millionaires into This Sector?

    Millionaire investors—and those who follow them—should take another look at the current economic situation before making any more investment decisions.
  7. Professionals

    What to do During a Market Correction

    The market has corrected...now what? Here's what you should consider rather than panicking.
  8. Mutual Funds & ETFs

    ETF Analysis: Vanguard Mid-Cap Value

    Take an in-depth look at the Vanguard Mid-Cap Value ETF, one of the largest and most popular mid-cap funds in the U.S. equity space.
  9. Mutual Funds & ETFs

    ETF Analysis: Schwab US Broad Market

    Take an in-depth look at the Schwab U.S. Broad Market ETF, an incredibly low-cost fund based on a wide selection of the U.S. equity market.
  10. Professionals

    Tips for Helping Clients Though Market Corrections

    When the stock market sees a steep drop, clients are bound to get anxious. Here are some tips for talking them off the ledge.
RELATED TERMS
  1. Equity

    The value of an asset less the value of all liabilities on that ...
  2. Hard-To-Sell Asset

    An asset that is extremely difficult to dispose of either due ...
  3. Sucker Yield

    When an investor has essentially risked all of his capital for ...
  4. PT (Perseroan Terbatas)

    An acronym for Perseroan Terbatas, which is Limited Liability ...
  5. Ltd. (Limited)

    An abbreviation of "limited," Ltd. is a suffix that ...
  6. BHD (Berhad)

    The suffix Bhd. is an abbreviation of a Malay word "berhad," ...
RELATED FAQS
  1. 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 >>
  2. Why would a corporation issue convertible bonds?

    A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
  3. How does additional paid in capital affect retained earnings?

    Both additional paid-in capital and retained earnings are entries under the shareholders' equity section of a company's balance ... Read Full Answer >>
  4. What types of capital are not considered share capital?

    The money a business uses to fund operations or growth is called capital, and there are a number of capital sources available. ... Read Full Answer >>
  5. What is the difference between issued share capital and subscribed share capital?

    The difference between subscribed share capital and issued share capital is the former relates to the amount of stock for ... Read Full Answer >>
  6. What happens to the shares of stock purchased in a tender offer?

    The shares of stock purchased in a tender offer become the property of the purchaser. From that point forward, the purchaser, ... Read Full Answer >>

You May Also Like

COMPANIES IN THIS ARTICLE
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!