Buy or sell-Ericsson a long-term winner with short-term issues

Ericsson (Stockholm, Sweden), the world’s top supplier of telecom network infrastructure, is seen enhancing its competitive advantage over rivals, but the global downturn and pressure on the gross margin will leave the share vulnerable to setbacks.


Of 36 analysts tracked by Reuters, two had an underperform or sell recommendation for Ericsson stocks, while nine had a hold on the stock.


BUY



Ericsson (Stockholm, Sweden), the world’s top supplier of telecom network infrastructure, is seen enhancing its competitive advantage over rivals, but the global downturn and pressure on the gross margin will leave the share vulnerable to setbacks.


Of 36 analysts tracked by Reuters, two had an underperform or sell recommendation for Ericsson stocks, while nine had a hold on the stock.


BUY


Ericsson is the market leader in wireless infrastructure. It has been gaining share in recent quarters, sacrificing gross margin to expand its operator base in Europe. This should lead to more and higher-margin sales over the next few years.


Surging smartphone and tablet computer sales are driving demand for mobile broadband and clogging up networks in developed countries. Even with the macro-environment souring, operators need to build out capacity. Spending on faster 4G networks will pick up over the next few years.


“It is clear that Ericsson is the strongest player and is winning in most of the segments,” said Morten Imsgard, analyst at Sydbank (Aabenraa, Denmark), who has a positive recommendation on the stock.


Nokia Siemens Networks (Espoo, Finland) is restructuring and will shed a quarter of its workers. Alcatel-Lucent (Paris, France), scaled back its profitability goal for the year. . Analysts believe both could drop out of the market. That would leave two big players, Ericsson and Huawei (Shenzhen, P.R.C.) and ease long-term pricing pressure.


Ericsson stock is relatively cheap. It trades on a forward EV/EBITDA of around 5 against 5.5 for the sector, according to Thomson Reuters Starmine Estimates, well below its long-term historical median.


“On the positive side, there is the current valuation and I would say this is quite a good entry point for long-term investors,” said Thomas Langer, analyst at WestLB (Düsseldorf, Germany), who said he had a mild add recommendation on the stock.


Ericsson’s strong balance sheet, focus on cost and ability to cut R&D spend in hard times were also seen as positive factors. Analysts saw a slowdown in the key North American market as temporary.


SELL


Short-term there is pressure on the firm. The global macro picture is grim, though telecoms operators are often slower than most to cut spending. Ericsson’s gross margins are under pressure from a spike in hardware-heavy contracts in Europe.


“The gross margins, when they are weak, they are weak, and usually they are punished for that in a share-price perspective,” Helena Nordman-Knutson, analyst at brokerage Pareto Ohman (Stockholm, Sweden), said. She did not give her stock recommendation.


Gross margin fell to 35% in the third quarter from 39% a year earlier. Fourth quarter gross margin is seasonally weak and there are few signs it will improve until later next year when the effects of European modernization projects begin to wash out.


Data traffic growth has not translated to higher revenues for telecom operators.


“I still see problems charging for the volume increases you see in mobile broadband,” said Lars Soderfjell, analyst at Alandsbanken (Aland, Sweden). “That means I really don’t see operators will be able to spend more on network equipment. I don’t see it happening in the near term — within the next year or so.”


He said at current share-price levels it was tough to be too bearish on Ericsson. “But, it is hard to see any upside triggers over the next 3-6 months,” he said.


A significant revenue surprise would lift the shares, but given the macro-economic climate, “I don’t think that is very likely,” Soderfjell added.


Some analysts said that NSN and Alcatel-Lucent were likely to become more aggressive not less, as they look to build up scale in their search for long-term profitability.


Ericsson’s exposure to loss-making chip joint-venture ST-Ericsson was also seen as negative.


 (Reporting by Simon Johnson; Editing by Jodie Ginsberg)