Juniper Networks (NYSE:JNPR) announced a strong set of Q4 2012 results Thursday, beating its guidance on both the revenues and gross margins front. This was driven primarily by demand from service providers in the U.S. as well as continued traction for its new routing and switching products such as PTX, T4000 and QFabric. Improving mix of the higher-margin new products as well as ongoing cost reduction initiatives such as headcount reduction helped Juniper beat its operating margins guidance by over 200 basis points on the high end.
The networking vendor however commented that the macroeconomic concerns surrounding the Euro debt crisis haven’t yet subsided and therefore continued to offer subdued guidance for the next quarter. 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. Still, we continue to be positive about Juniper’s outlook as the long-term trends of data growth and mobility remain strong, which the company should be able to capitalize on with its new products gradually gaining more momentum.
In line with this view, Juniper’s stock has risen almost 34% in the last two months and is now about 15% below our $25 price estimate for the company. We are in the process of updating our price estimate for the Q4 earnings.
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Data demand grows despite macro concerns
As long as the macroeconomic conditions remain uncertain, Juniper’s customers are likely to continue to be cautious with capital spending. However, Juniper said during the earnings call that it expects service provider spending in the U.S. to continue and that it is seeing signs of improvement in EMEA spending. While Juniper’s guidance for Q1 2013 isn’t very rosy, it implies a y-o-y growth of about 3% at the midpoint – much better than the decline of 6% seen in Q1 results last year.
It is however too early to say if business and service provider spending on network infrastructure has returned. This uncertainty is an industry-wide concern, with even the industry heavyweight Cisco maintaining a conservative stance while setting quarterly expectations. The macro concerns have however had little impact on data demand which continues to be strong, driven by the key trends of mobile Internet and cloud computing. With the proliferation of mobile devices such as smartphones, e-readers and tablets, mobile data traffic has grown exponentially. According to a recent Cisco VNI report, mobile data traffic grew 133% in 2011 and is expected to grow at a CAGR of close to 80% over the next five years. ((Global Mobile Data Traffic Forecast Update, 2011–2016, Cisco, February 14th, 2012))
The ongoing economic concerns have therefore only resulted in longer project cycles and extended delivery timelines from customers. Network spending, and hence Juniper’s revenues should once again grow as economic conditions stabilize. Service providers, who will need to buy networking gear to support the burgeoning demand for data, account for almost two-thirds of Juniper’s revenue with some of the largest U.S. wireless carriers such as Verizon contributing as much as 10% for the full year 2012. AT&T, also one of Juniper’s bigger customers, has increased its CapEx guidance by $14 billion over the next four years.
Further, we see Juniper’s recognition of the SDN threat and its coming up with a strategy to counter that to be a big positive for it not only mitigates the impact of hardware commoditization but also positions it well for a new trend that has been gaining ground. (see Juniper Unveils New Strategy Mitigating Software-Defined Network Threat)
R&D spend a good sign of continuing innovation
As a consequence of the slump in network spending, Juniper has had to take a margin hit due to the high fixed costs for its innovation business. Its operating expenses increased in 2011 even as revenues dropped due to high levels of R&D investment that the company maintained throughout the year. What we like here is that in 2012 as well, despite the decline in revenues, the management has not cut down on these expenses to boost margins. While gross margins for Q4 saw an y-o-y of almost 200 basis points, operating margins declined as R&D expenses continued to mount.
This is a good sign because thanks to the relentless R&D spend, the company is now seeing market share gains on its new products. The positive impact could be seen in last quarter’s small guidance beat, but the effect will be even greater when the global economic conditions improve. The new products have also helped increase the mix of higher-margin routing products, thereby bolstering Juniper’s gross margins which have improved more than 300 basis points since the start of 2012.
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. This impact would however be gradual since new products generally need time in the market to start having a meaningful impact.