Ericsson (ERIC) On Restructuring Track, Weak RAN Markets Mar

The network infrastructure and 4G deployment field has been buzzing with a flurry of recent activity and Ericsson (BS:ERICAs) (NASDAQ:ERIC) has undoubtedly been quite in the thick of things. However, the company continues to grapple with low investments in mobile broadband and all-pervasive weak demand.

The beleaguered infrastructure giant’s repeated earnings misses, eroding profitability and its steep revenue decline have left investors high and dry. The stock has lost 8% in the past six months in contrast to the industry’s gain of 2.2%.

The Headwinds & Numbers

Most of the company’s troubles have stemmed from flagging investments by major telecom equipment makers across the world. Particularly, uncertainty in the financial markets, reduced consumer telecom spending and delayed auctions of spectrums pose significant threats to Ericsson. Its revenues and margins in the Networks and IT & Cloud segments continue to take a serious beating from adverse industry trends.

In third-quarter 2017 earnings report, declining product demand, lower software sales and dull legacy products sales pushed the company’s earnings into the red with the Swedish firm accounting for a huge net loss of SEK 4.3 billion ($528.5 million), much wider than the loss of SEK 0.2 billion, witnessed a year ago. The wireless communications gear maker has lost money for the fourth straight quarter, marking its seventh consecutive earnings miss.

Looking Into the Future

Ericsson said that it expects a high single-digit percentage drop in the market for radio access networks (RAN) this year, which is worse than the previously-projected figure. Network equipment sales, particularly in the North America and Europe markets, continue to decline.Europe and Latin America — the markets with the biggest impact — are likely to face an increasingly challenging investment environment in the quarters to come.

Overall, the company expects unfavorable industry trends and business mix in mobile broadband to persist this year as well.

Nevertheless, Ericsson still hopes to stabilize its operations amid a difficult market next year and remains hopeful of reaching its targeted operating margin of 12% beyond 2018. Slight positives from further managed service contract renegotiation and higher network software sales in the near future will likely be counteracted by strong headwinds of loss of momentum in China and loss of scale.

Restructuring: Ray of Hope?

As of now, the only potential upside to earnings in the near future seems to be via expense management.

Ericsson had earlier announced a restructuring plan to cut costs and streamline the company’s focus areas as well as explore options for the media business. The company now aims to reduce capitalization of its product platform, software-release development costs and hardware costs, which in turn would likely lower operating income for the second half of 2017 by SEK 2.9 billion.

There is also an elevated risk of market and customer project adjustments, which can leave a negative impact of SEK 3-5 billion on the operating income in the coming 12 months. Ericsson’s CEO recently warned that an uncertain market could wipe out as much as SEK 5 billion of operating income over the next year.

Ericsson further intends to implement cost savings with an annual run rate effect of at least SEK 10 billion ($1.2 billion) by mid-2018. Restructuring charges for 2017 are now anticipated in the range of SEK 9-10 billion (up from the previous projection of SEK 6-8 billion).

The Big Picture

More restructuring charges are knocking on Ericsson’s door and we also have a subdued view of operator spending and investments in R&D. Further adding to the woes, the company’s current savings plans and job reductions are not sufficient enough to counter macroeconomic miseries and swiftly waning product demand.

Ericsson plans to accelerate its planned cost cuts and expedite expansion plans that aren’t moving as anticipated and reset the company’s focus on business of selling networking equipment prior to the expected roll-out of 5G networks.

With numerous headwinds on the company’s radar, several analysts have downgraded Ericsson since September, thanks to a bleak view of the company's revenues and margins. They believe that a rollout of the 5G technology won't provide enough boost to the company's revenue base. Investors looking for exposure to the upcoming 5G upgrade cycle or Internet of Things might consider better-placed players namely, Nokia (HE:NOKIA) Corporation (NYSE:NOK) and Cisco Systems, Inc. (NASDAQ:CSCO) .

The consensus analyst community’s apathy toward the stock is reflected in its downward earnings estimate revisions. The stock has seen the Zacks Consensus Estimate for current-year earnings being revised downward to a dismal loss of 13 cents from earnings of 3 cents over the past 60 days. This downtrend move was triggered by four downward estimate revisions versus none upward.

Ericsson Price, Consensus and EPS Surprise

Summing Up

However, against all odds, Ericsson expects the restructuring plan to help streamline its focus areas, improve profitability and revitalize its technology and market leadership. The company also plans to explore options for its media business and review the low-performing contracts in its managed service business.

It remains to be seen if the abovementioned steps will allow Ericsson to jump back on the growth track. Sadly enough, the stock still carries a Zacks Rank #5 (Strong Sell) and we are deeply concerned with its restructuring effects. Additionally, the impact of tough market conditions on the company’s profits and its near-term share price movement also raises concern.

Stock to Consider

A better-ranked stock in the broader sector is Red Hat, Inc. (NYSE:RHT) , carrying a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Red Hat has a robust earnings surprise history with an average beat of 7%. The bottom line has surpassed estimates in three of the trailing four quarters.

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