Juniper Networks (NYSE:JNPR) announced a better-than-expected Q2 2012 results on July 24th, beating its own revenue guidance on the high-end by 1%. This was driven primarily by an increased adoption of its new routing and switching products such as PTX, T4000 and QFabric. Gross as well as operating margins increased sequentially as the company managed to move more of its high-margin routing products as well as decrease some of its operating costs. However, the networking vendor offered subdued guidance for the current quarter citing near-term macro-economic uncertainty surrounding the European debt crisis. 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.
The markets responded positively to the revenues and margins beat, rising more than 10% since the earnings call. We are positive about Juniper’s long-term outlook as well, but see more value in the company. We maintain our price estimate of $26, which is around 60% ahead of the current market price.
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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 in the near-term. While Juniper’s revenues improved sequentially, when seen year-over-year, they registered a decline of 4%. Juniper’s guidance for the next quarter, at the mid-point, also implies a similar decline over the same period last year. While the outlook over the next few quarters remains challenging, we 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 12%, as of Q2 2012.
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. Its R&D expenses so far this year show no signs of slowing down as well. Therefore, while operating margins for Juniper improved sequentially due to lower G&A expense, it showed a y-o-y decline of 7% as R&D expenses continued to mount.
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 can already be seen with this quarter’s small revenue beat but the effect will be even greater when 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 have been declining for quite some time now. Last year, margins declined by more than 2% to about 67% 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. A higher routing mix supported by the new product launches have since resulted in product margins improving sequentially in Q1 2012 and remaining nearly flat in Q2.We expect the new routing products to continue to improve the firm’s overall product mix toward the higher-margin routing products, providing support for its declining product gross margins as a result.