Communication Infrastructure Appears Mired in Bearish Trends

The Zacks Communication - Infrastructure industry comprises companies that provide various infrastructure solutions for the core, access and edge layers of communication networks. These firms support mission-critical, high-bandwidth applications like cloud-based computing, video, mobile and machine-to-machine connectivity. Leveraging proprietary modeling and simulation techniques to optimize networks, the firms offer high-speed network access solutions for use across Internet protocol, asynchronous transfer mode and time division multiplexed architectures in both wireline and wireless network applications to leading global telecom operators, multi-system operators and enterprise customers. Their product portfolio encompasses optical fiber and twisted pair structured cable solutions, infrastructure management hardware and software, network racks and cabinets, and fiber-to-home equipment like hardened connector systems, couplers and splitters, and hardened optical terminating enclosures.

In addition, some firms provide materials for cellular base station sites and connectivity; indoor, small cell and distributed antenna wireless systems; and wireless network backhaul planning and optimization products and services to improve cellular coverage and capacity in high-traffic areas and places difficult for networks to penetrate. Certain firms within the industry provide data center infrastructure solutions that include colocation space and power, and interconnection services to various enterprise, cloud, carrier and content customers.

Here are the three major themes in the industry:

•    With exponential growth in video and other bandwidth-intensive applications owing to the wide proliferation of smartphones and increased deployment of superfast 5G technology, the industry participants are making considerable investments in LTE, broadband and fiber in order to provide additional capacity and ramp up the Internet and wireless networks. As a result, these companies are rapidly transforming from legacy copper-based telecommunications firms to technology powerhouses with capabilities to meet the growing demand for flexible data, video, voice and IP solutions. At the same time, the industry participants are focusing on leveraging wireline momentum, expanding media coverage, improving customer service and achieving a competitive cost structure to generate higher average revenue per user, while attracting new customers.

•    The success of 5G hinges on substantial investments to upgrade infrastructure in the core fiber backhaul network to support anticipated growth in data services. With operators moving toward converged or multi-use network structures, combining voice, video and data communications into a single network, the industry is increasingly developing solutions to support wireline and wireless network convergence. Although these investments will eventually help minimize service delivery costs to adequately support broadband competition, rural coverage and wireless densification, short-term profitability has largely been compromised. The industry's near-term prospects also remain vulnerable to a number of factors like risks of disruption from extreme weather and the growing menace of cyberattacks. Efforts to build resilient infrastructure facilities to withstand natural catastrophes have further increased operating costs. Moreover, various trade restrictions imposed on the sale of communication equipment to China-based firms have dented the industry's credibility and led to loss of some businesses.

•    Paucity of demand due to geopolitical uncertainty and the challenging macroeconomic environment has dented the margins of most industry participants. Intense price wars due to rising costs of raw materials and stiff competition have added to the woes. Consumer acceptance of alternative communications technologies such as coaxial cable through cable/multiple system operators, and cellular-based wireless services have further strained margins. High technological obsolescence of most products has also escalated operating costs with continuous investments in R&D. These negative impacts have become all the more pronounced as the coronavirus pandemic continues to spook financial markets in one of the worst declines in the recent past, hurting economic growth and triggering large-scale unemployment, affecting the overall demand pattern.

Overall, despite inherent growth potential, the industry appears to be mired in short-term headwinds and uncertainty, with significant capital expenditures and price wars eroding margins amid the coronavirus-induced market turmoil.

Zacks Industry Rank Indicates Gloomy Prospects

The Zacks Communication - Infrastructure industry is housed within the broader Zacks Computer and Technology sector. It carries a Zacks Industry Rank #201, which places it at the bottom 20% of more than 250 Zacks industries.

The group’s Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates bleak prospects. Our research shows that the top 50% of the Zacks-ranked industries outperform the bottom 50% by a factor of more than 2 to 1.

The industry’s positioning in the bottom 50% of the Zacks-ranked industries is a result of negative earnings outlook for the constituent companies in aggregate. Looking at the aggregate earnings estimate revisions, it appears that analysts are losing confidence in this group’s earnings growth potential. In the past year, the industry’s earnings estimates for the current fiscal year have declined 57.6%.

Before we present a few communication infrastructure stocks that are well positioned to outperform the market based on a strong earnings outlook, let’s take a look at the industry’s recent stock market performance and valuation picture.

Industry Outperforms Sector and S&P 500

The Zacks Communication - Infrastructure industry has outperformed the broader Zacks Computer and Technology Sector as well as the S&P 500 composite over the past year.

The industry has risen 49.7% over this period against the S&P 500 and the sector’s rise of 18.3% and 40.9%, respectively.

One Year Price Performance

Industry’s Current Valuation

On the basis of trailing 12-month enterprise value-to EBITDA (EV/EBITDA) ratio, which is the most appropriate multiple for valuing telecom stocks, the industry is currently trading at 9.04X compared to the S&P 500’s 12.86X. It is also trading below the sector’s trailing 12-month EV/EBITDA of 13.69X.

Over the past five years, the industry has traded as high as 12.93X, as low as 6.70X and at the median of 8.85X, as the chart below shows.

Trailing 12-Month enterprise value-to EBITDA (EV/EBITDA) Ratio

Bottom Line

The industry should gradually recover once the market stabilizes with the likely arrival of the coronavirus vaccine ebbing the adverse impact of the virus outbreak and as the effect of capital investments percolates. However, it is likely to face operational headwinds in the near term.

None of the stocks in the space currently sports a Zacks Rank #1 (Strong Buy). You can see the complete list of today’s Zacks #1 Rank stocks here.

We are presenting two stocks with a Zacks Rank #2 (Buy).

Calix, Inc. (CALX): Headquartered in San Jose, CA, this communications infrastructure provider has gained a stellar 234.7% in the past year and delivered an earnings surprise of 59.7%, on average, in the trailing four quarters. The Zacks Consensus Estimate for current fiscal-year earnings has moved up 67.7% since August 2019, while that for the next fiscal has increased 60% since October 2019.

Price and Consensus: CALX

ADTRAN, Inc. (ADTN): Based in Huntsville, AL, this communications infrastructure provider has delivered an earnings surprise of 50.2%, on average, in the trailing four quarters. The Zacks Consensus Estimate for next fiscal-year earnings has moved up 106.7% since November 2019.

Price and Consensus: ADTN

We are also presenting a stock with a Zacks Rank #3 (Hold) that is well positioned to grow.

Bandwidth Inc. (BAND): Headquartered in Raleigh, NC, this communications infrastructure provider has gained 79.5% in the past year. The Zacks Consensus Estimate for current and next fiscal-year earnings has moved up 121.1% and 151.5%, respectively, over the past year.

Price and Consensus: BAND

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

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