Buy This Balance Sheet

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We can all be thankful for the remarkable rebound in the stock market, which has helped to rebuild many portfolios during the past 11 months. Stocks may power yet higher if the economy is indeed on the mend, but concerns remain that we're due for another slowdown. In a time like this, you may as well stick with stocks that possess leverage to an economic upturn, but are likely to hold their own if the market cools off. You can find those "safe stocks" by looking for balance sheet strength.

With its mountains of cash telecom equipment maker Tellabs (Nasdaq: TLAB) is one company that provides comfort.

Tellabs was early to the internet/telecom revolution, providing high-end gear to phone companies since 1974. The company has always sought to increase the efficiency of those networks, and was a key player in the effort to help voice networks handle increasing volumes of data. Of course, it's been a long time since that industry was in high-growth mode, which explains why this stock once fetched more than $80 but now trades for less than $7.

Though the days of sizzling growth are over, Tellabs looks set to start growing at a moderate pace in the years to come. That's because the company is rolling out gear that helps telecom providers handle the rising volume of data that is being pushed out to mobile devices such as Apple's (Nasdaq: AAPL) iPhone and Research in Motion's (Nasdaq: RIMM) Blackberry. Telecom operators are having a hard time keeping up with the explosive demand for faster speeds and large video files that are increasingly being viewed on mobile devices. Apple's coming iPad tablet, along with a raft of similar products, should only stoke mobile traffic even higher. (For another way to profit from the booming smartphone market, see "Stock #5" in this report. The company gained more than +150% last year and is poised to crush the S&P 500 again in 2010.)

The economic slowdown led Tellabs' customers to defer any non-essential spending, which explains why sales fell another -12% in 2009 to around $1.5 billion. But the sales plunge appears to be at an end. Management expects first-quarter sales to be around $370 million, roughly $10 million above year-ago levels. That would mark the first year-over-year quarterly increase in several years. As a result, sales and earnings estimates, which had been steadily falling, are now starting to rise. Management's confidence is aided by the fact that book-to-bill, which compares incoming orders to actual sales, was above 1.0 in the fourth quarter of 2009.

To be sure, Tellabs' sales rebound will likely be modest, perhaps in the +5% to +10% range once the economy is truly back on sustainable footing. But that should be sufficient to drive profit growth at a faster clip. That's because management has been steadily cutting costs, which is giving a clear boost to gross margins and operating margins. In the most recent quarter, gross margins rose 370 basis points from a year earlier to 45.2%. Gross margins were also aided by a shift in the sales mix to newer cutting-edge products. Operating margins, which were barely positive a year ago, hit an impressive 9.0% in the most recent quarter. And they could exceed 10% in coming quarters, as management plans to shed an additional 200 jobs.

Rising profits are being aided by an ever-shrinking share count: The company bought back 12 million shares in 2009, and is expected to keep buying stock in 2010 as well. That's the benefit of having a super-strong balance sheet. Tellabs' has more than $1.3 billion in cash. That accounts for exactly half of the company's market value. So if the economy cools and the stock market pushes this stock back down, then the company's ongoing stock buyback program will simply be able to buy an even greater number of shares.

Meanwhile, shares trade at a discount to rivals Ciena (Nasdaq: CIEN) and Adtran (Nasdaq: ADTN) . Tellabs' enterprise value (market capitalization plus debt minus cash), as a percentage of projected 2010 sales, is below 1.0, while those other firms trade at 1.2 times and 2.3 times, respectively. And enterprise value, as a multiple of operating cash flow, is just 5.5 times for Tellabs, while that ratio is 96 times and nine times, for its respective rivals.

A strong balance sheet, attractive valuations, and a brightening sales picture? What more could a value investor ask for?

-- David Sterman
Contributor
StreetAuthority

Disclosure: David Sterman does not own shares of any security mentioned in this article.



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.

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This article appears in: Investing , Stocks

Referenced Stocks: AAPL , ADTN , CIEN , RIMM , TLAB

David Sterman

David Sterman

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