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Juniper's Well Positioned Heading Into Earnings Despite Weak Macro
Juniper Networks ( JNPR ) is expected to announce its Q4 2012 results on January 24. The networking vendor has of late seen its new products gain healthy traction in the marketplace, helping it regain second position behind Cisco ( CSCO ) in the router market and push Huawei down to fourth in Q3 2012. This saw Juniper beat its last quarter revenue guidance on the high-end by 4%. What was most pleasing about last quarter's results was that the guidance beat had come about despite a 5% y-o-y drop in the size of the overall service provider market - a market segment that contributes almost two-third of Juniper's revenues.
However, Juniper again provided subdued guidance for Q4, implying that the near-term macro-economic uncertainty surrounding the European debt crisis will continue to be an overhang on the industry. All eyes will therefore be on the Q4 results to see if an increased adoption of Juniper's new products has once again helped it overcome macro challenges. Concerns over the macro environment are taking a toll on competitors Alcatel-Lucent ( ALU ) and Cisco as well, with the latter doing slightly better than the rest. Still, we continue to be positive about Juniper's outlook as the long-term trends of data growth and mobility remain strong, which the company should be able to capitalize on as its new products gradually gain more momentum. In line with this view, Juniper's stock has risen almost 33% in the last two months and is now about 15% below our $25 price estimate for the company.
See our full analysis of Juniper Networks
Watching revenue growth
With macroeconomic uncertainty likely to persist in the near term, we expect Juniper's customers to continue to be cautious with capital spending. While the company managed to grow Q3 revenues by 4% sequentially, its guidance for Q4 implies a roughly flat quarter y-o-y at the midpoint. This is however an industry-wide concern given that even Cisco continues to maintain a conservative stance while setting quarterly expectations. However, we see this as only a near-term phenomenon since the ongoing economic concerns have only resulted in longer project cycles and extended delivery timelines from customers. Network spending, and hence Juniper's revenues should once again grow as economic conditions stabilize.
Further, we see Juniper's recognition of the SDN threat and its coming up with a strategy to counter that to be a big positive for it not only mitigates the impact of hardware commoditization but also positions it well for a new trend that has been gaining ground. (see Juniper Unveils New Strategy Mitigating Software-Defined Network Threat)
Additionally, since the broader market continues to be strong, driven by the key trends of mobile Internet and cloud computing, we expect higher demand for Juniper's products and services as mobile devices such as smartphones, e-readers and tablets proliferate. Mobile data traffic grew 133% in 2011 and is expected to grow at a CAGR of close to 80% over the next five years, according to a recent Cisco VNI report. Service providers, who will need to buy networking gear to support the burgeoning demand for data, account for almost two-thirds of Juniper's revenue with some of the largest U.S. wireless carriers such as Verizon contributing as much as 12% as of Q2 2012. AT&T, also one of Juniper's bigger customers, has increased its CapEx guidance by $14 billion over the next four years.
R&D spend a good sign of continuing innovation
As a consequence of the slump in revenue growth, Juniper has had to take a margin hit due to high fixed costs for its innovation business. Its operating expenses increased in 2011 even as revenues dropped due to high levels of R&D investment that the company maintained throughout the year. What we like here is that in 2012 as well, despite the decline in revenues, the management has not cut down on these expenses to boost margins. While operating margins for Q3 improved sequentially due to higher gross margins, it showed a y-o-y decline of over 300 basis points as R&D expenses continued to mount.
This is a good sign because thanks to the relentless R&D spend, the company is now seeing market share gains on its new products. The positive impact could be seen in last quarter's small guidance beat, but the effect will be even greater when the global economic conditions improve. The new products have also helped increase the mix of higher-margin routing products, thereby bolstering Juniper's gross margins which had declined by more than 2% in 2011.
We expect the new routing products to continue to improve the firm's overall product mix toward higher-margin routing products, providing support for its declining product gross margins as a result. This impact would however be gradual since new products generally need time in the market to start having a meaningful impact.