Juniper Earnings Will Be Weak But Data Demand Drives $26 Value

Juniper Networks (NYSE:JNPR) is expected to announce its Q2 2012 results on July 24. During the last quarter’s earnings call, the company had guided for a flat Q1 both in terms of revenues and profits, which indicates that its operating expenses will continue to mount despite a continued slowdown in routing and switching solutions. The macro-economic uncertainty surrounding the European debt crisis has forced enterprises to cut spending on network infrastructure, which in turn is impacting Juniper’s earnings. Concerns over the macro environment are also taking a toll on competitors Alcatel-Lucent (NYSE:ALU) and Cisco (NASDAQ:CSCO), with the latter doing slightly better than the rest.

In-line with the weak near-term outlook, Juniper’s stock has taken a beating in recent months. However, we are positive about Juniper’s long-term outlook and maintain a price estimate of $26, which is around 80% ahead of the current market price.

See our full analysis of Juniper Networks

Revenue growth has slowed down, but not for long

As the macro environment remains challenging, we expect Juniper’s customers will continue to remain cautious on capital spending. If Juniper’s revenues for the quarter end up close to its last quarter revenues as guided, it will imply a decline of about 5% over the same period last year. While we believe the outlook over the next few quarters remains challenging, we also see this as a near-term phenomenon since the ongoing economic concerns have only resulted in longer project cycles and extended delivery timelines from customers. This implies that revenues will go up again as the economic conditions stabilize over the next few years.

Besides, since the broader market continues to be strong driven by two key trends of mobile Internet and cloud computing, we expect the demand for Juniper’s router and network management services from service providers will grow as mobile devices such as smartphones, e-readers and tablets proliferate. Service providers account for almost two-thirds of Juniper’s revenue, with some of the largest U.S. wireless carriers such as Verizon contributing almost 15%.

New products drive Juniper’s value

As a consequence of declining revenues, Juniper has had to take a margin hit due to the high fixed-cost nature of its innovation business. Juniper’s operating expenses increased in 2011 even as revenues dropped due to the sustained high level of investment in R&D that the company maintained throughout the year. Thanks to that investment, however, Juniper has an extended products and solutions portfolio in 2012 that can better help it tide over the ongoing economic concerns. The positive impact will be even greater if the global economic conditions improve.

We expect the company’s operating expenses to remain high, going forward, as Juniper continues to invest in R&D to come up with new versions of its core router and switching products such as the T4000 and PTX launched last year, which have so far done well to win clients in a fast-changing environment.

Juniper’s product gross margins declined by 130 basis points to about 68% in 2011. This was due to the relatively lower volumes for its routing business, which accounts for about 40% of the company’s value by our estimates. However, we saw product margins improve sequentially in Q1 2012 due to a higher routing mix supported by the new product launches. We expect the new routing products to continue to improve the firm’s overall product mix toward higher-margin routing products, providing support for its declining product gross margins as a result.

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