ADVA Optical Networking: Profitability Maintained Despite Revenue Drop

ADVA Optical Networking (ADV:DE) reported Q4 revenues in line with guidance and better than expected profitability. However, guidance for Q113 was below our expectations and we have cut our estimates accordingly. Medium-term growth drivers are still in place, but the timing of the rebound in the near term is hard to predict. ADVA continues to trade at a discount to peers, despite its strong balance sheet and good growth track record.

Profitability maintained despite revenue drop
As flagged at Q3 results, the trading environment is volatile, with carriers continuing to focus spending on 4G wireless projects. ADVA reported Q4 revenues in the top half of guidance and operating margins at the top of the 2-6% guidance range (6.0% vs 6.8% in Q312 and 8.9% in Q411) despite a 2.4% q-o-q (3.8% y-o-y) decline in revenues. Profitability was helped by better than expected gross margins and good control of operating expenses. The company continued to grow market share in the Ethernet Access Device market, despite the weaker environment.

Outlook weaker; medium-term growth intact
ADVA guided to weaker than expected Q113 revenues (€72-77m vs our €78.4m), with an operating margin of -2% to 2%. We have revised down our revenue estimates for FY13, assuming weak revenues in H1 followed by a return to growth in H2, to achieve growth of 1.7% for the year. We continue to forecast 10% revenue growth in FY14 as we expect demand to recover; while capex can be deferred in the short term, carriers and enterprises wanting to remain competitive will have to make investments at some point. We have revised down our normalised EPS forecasts by 5% in FY13 and 14% in FY14.

Valuation: Relative valuation remains compelling
Although current trading is difficult and 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 15.3x and EV/sales of 0.5x, the shares continue to trade at a discount to peers and our DCF (€5.31).

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