ADVA Optical Networking

ADVA has caught the industry’s cold and even its strong new product sales were not enough to offset a fall in wire-line investment towards the end of Q3. Weakness is expected to continue into Q4 and we have cut our 2012 EPS estimates by 25%. The shares trade at an attractive discount to peers considering its ongoing revenue outperformance (albeit from a lower base).

Q3 Results At The Lower End Of Guidance
The weakness in the optical equipment market has eventually caught up with ADVA which reported Q3 revenues at the lower end of guidance (€82.3m +3.7% y-o-y). The strength in new product sales (highlighted at the investor day) was not sufficient to offset the general market malaise and sales in the last few weeks of the quarter suffered as operators diverted capex into 4G wireless projects. Despite the rapid change in the sales environment, management’s ongoing focus on costs enabled it to deliver operating margins of 6.8% (guidance 6% to 8%).

Rest Of The Year Expected To Be Weak; Estimates Cut
Management is guiding for Q4 revenues down 2% to 8% (€77m to €82m) and operating margin of 2% to 6%. We are cutting our 2012 estimates to reflect the weaker H2, and have assumed that this will continue into the first half of 2013 before recovering in H213. The net impact of our lower revenue and margin estimates is to cut our EPS forecasts by 25% and 33% in 2012 and 2013 respectively.

Valuation: Relative Valuation Remains Compelling
Although current trading is difficult, ADVA’s revenue performance continues to be industry leading. While there is no clear near-term catalyst, we believe the medium-term investment case remains compelling: the Optical and Ethernet segments offer structural growth driven by the bandwidth strains felt by networks; with its exclusive focus on growth niches, ADVA is not compromised with legacy technologies; its strong balance sheet means new product development is enabling it to significantly expand its addressable market and offset some of the general market weakness; and in a difficult trading climate ADVA may benefit from sector consolidation. On a current year P/E of 15.5x and EV/Sales of 0.5x, the shares continue to trade at a discount to peers and our DCF (€5.08).

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