Watching and Waiting
Another wishy-washy week for tech stocks, as last week’s jobs number called into question one of the few underpinnings of the bull market case for continuing to acquire stocks aggressively. Only 126,000 non-farm payroll jobs were added to the U.S. economy in March, about 50% less than what was added in the prior month. The energy sector and bad weather are being blamed for much of the decline, but construction and manufacturing jobs fell by only 1,000 so the weather probably wasn’t that much of a factor. No doubt the energy sector is feeling the pinch of low oil prices, but in theory that should be somewhat offset by job growth in other sectors that benefit from the extra dollars in consumers’ pockets as a result of cheaper fuel prices.
We think what is really holding tech stocks down is concern over the strong dollar, especially now that we are entering into the second round of quarterly earnings reports this year. Over the course of the next month we will hear from almost every major tech company, and get a sense for just how severely their profitability has been impacted by currency values.
However, we’ll be keeping our eye on unit volumes and market share, as in the long run that is of far greater importance than a temporary write down of sales revenue caused by the strong dollar. In fact, this may turn out to be just the opportunity many of us have been waiting for to buy quality companies at a discount if nervous sellers panic over seemingly poor quarterly results that have been artificially impacted by currency revaluations.
If that happens, stocks such as the ones reviewed below may drop down into our “buy zone.” In his sector spotlight article Rob DeFrancesco writes about one such company that he likes but may be a bit overvalued at the moment, while in her sector spotlight article Linda McDonough explains why now may not be the time to buy Intel at current prices.
NASDAQ Composite Index:
Thursday, April 2 = 4,886.94
Trailing 12 months = + 17.6%
Trailing 7 Days = – 0.1%
Trailing 4 Weeks = + 0.3%
Next Wave Portfolio Update—One to Watch: Ruckus Wireless
By Rob DeFrancesco
Hewlett-Packard (HPQ) last month agreed to acquire wireless networking equipment vendor Aruba Networks (ARUN) in an all-cash deal worth $2.7 billion (net of cash and debt). With Aruba in the mix, H-P will control about 19% of the wireless LAN equipment market, still well below the 51% share held by leader Cisco Systems (CSCO).
I am keeping an eye on another pure-play WLAN vendor: Ruckus Wireless (RKUS), which controls about 7% of the market. Last year, Ruckus saw top-line growth of 24%. The company generates two-thirds of its revenue from the enterprise segment and the remainder from service providers.
In 2014 Ruckus added more than 15,000 new enterprise accounts, bringing the total base to 48,000+ (Aruba has nearly 50,000 customers); more than 60 service provider customers were brought on, taking the total count to 200+. Ruckus controls about 27% of the service provider WiFi market.
For 2015, the consensus revenue estimate of $382.7 million indicates growth of 17.1%. As with Aruba, Ruckus expects to see better growth in the back half of the year because of the upcoming expansion of the FCC’s E-rate program (as much as an additional $2.5 billion will be spent over the next two years to support wireless broadband upgrades for schools and libraries), which kicks off in July.
Anywhere from 30% to 40% of the new spending is expected to flow to WiFi equipment vendors; the rest of the funds will be used for things such as cabling, switches and insulation.
Ruckus should be a major beneficiary of the E-rate expansion largesse, as the education vertical represents 20% to 25% of the company’s enterprise business. The E-rate tailwind will continue throughout 2016; top-line growth at Ruckus next year is expected to accelerate to 19.2%.
However, there has been a near-term pause in wireless spending in the K-12 education segment ahead of the new funding round (no surprise), one of the main reasons for the tempered growth this year. There is elevated risk that results for the March and June quarters might miss expectations.
Recently trading at $12.89, Ruckus shares have rebounded 41% from the January low of $9.11 (the 52-week high of $15.21 was reached last September), partially propelled by speculation that the company could be the next takeover target in the WLAN space. The forward P/E is up to 26.3, vs. Aruba’s takeout multiple of 21.6.
Investments Portfolio Update—Intel
By Linda McDonough
Intel (INTC) is an original member of the Smart Tech Investor Investments Portfolio, added on December 2, 2013 at a closing price of $23.53. Since then it has risen consistently, peaking a little above $37 in December. The stock has pulled back 15% since the beginning of the year and hovers around $30. Despite its 3% yield, Intel merits a mediocre 4.9 STR (Smart Tech Rating) score and a Hold rating due to its inability to grow its cash flow. Increasing rates of cash flow would allow Intel to dig deeper into the research and development of new products. Although we enjoy an unrealized gain of 35% in the stock, we are keeping our Hold recommendation until Intel can improve the growth of its cash flow.
It’s tough to turn around an ocean liner. Intel, with a market cap of $146 billion and annual sales of $56 billion, is making steady but painfully slow progress in revamping its business. The problem for Intel is that the company is still reliant on the fortunes of personal computing devices for its success. Chips sold for laptops and PCs still represent 62% of total revenue and a whopping 95% of Intel’s profits. In fact, the improvements scored in Intel’s server and data center businesses are almost imperceptible to investors’ eyes.
Intel seemed to be humming along when it reported its 4th quarter on January 15th. Revenue for all PC related chips was up 4% for the year, higher than originally expected and total revenue grew 6%. Earnings were up 22% due to improved profitability.
However, two months later on March 12th, the company made a brusque announcement that revenue for the first quarter would be flat, instead of its original projection of being up 7%. The company blamed the weakness on lower demand for business PCs and weakness in Europe. As the transition to Windows XP has been less than robust, many customers have chosen to hold less inventory and reduce their orders of chip parts from Intel. Even more unsettling is the decision of management to withdraw guidance for the entire year.
Cash flow, as noted above, is a good metric for how much capital a company can devote to future innovation. Unfortunately, Intel has not been able to grow its cash flow. Although the company did generate a healthy $20.4 billion of cash last year, this amount was down slightly from the previous year.
Another round of excitement erupted on March 27th when the Wall Street Journal reported that Intel was in talks to acquire Altera. Altera, based in San Jose just 6 miles from Intel’s corporate offices in Santa Clara, is the second largest producer of programmable logic devices (PLDs). These are versatile chips that can be programmed and tailored to carry out very specific functions. Altera is what is called a fabless semiconductor company. This means that they do not own a factory. Conveniently, the bulk of Altera’s chips are produced in Intel’s own factories. Intel is likely interested in the less commodity business of complex chips and could simply capture the sales, marketing and research functions for a product they are already making. Acquiring Altera would also allow Intel to diversify into the mobile communications industry.
While the deal has yet to be formally announced, stock prices for both Altera and Intel jumped on the rumor. Altera is a pip squeak compared to the giant Intel. Altera’s revenue of $1.9B for the last 12 months is 3% the size of Intel’s, and Intel’s profits were 27 times the size of Altera’s! Certainly, if the deal were to consummate, Intel would be looking for more than a bump to earnings from the acquisition. For sure, Intel is not sitting still as the PC business idles. However, we don’t recommend new purchases of the stock until the company can reboot earnings in a manner that grows revenue, profits and cash flow. We shall see what Intel has to say when they report first quarter earnings on April 14th.