A Resurgent Networking Market Can Lift Juniper Earnings But Enterprise May Spoil The Party

Juniper (NYSE:JNPR) is slated to announce its Q2 2013 earnings on July 23. The networking industry, as a whole, seems to be slowly pulling itself out of the mud with the macroeconomic environment in many countries such as the U.S. improving, and networking vendors such as Cisco (NASDAQ:CSCO) and Juniper posting good results. Last quarter, Juniper saw its revenues grow by over 2.5% y-o-y – a sharp improvement over the same period last year when revenues had declined by 6%. This out-performance was driven mostly by service provider sales, as U.S. carriers such as AT&T and Verizon invested in increasing data capacity and building out their LTE networks. As a result, the company’s new networking products such as T4000, PTX and QFabric have been gaining traction, allowing Juniper to meet more than 55% of its year-end quarterly revenue run rate guidance for the new products in the first quarter itself.

While service provider revenues have been growing y-o-y in the recent quarters, Juniper’s enterprise customers – particularly the U.S. Federal government – have been relatively more reluctant to loosen their purse strings. This is one of the big reasons why Juniper has guided for only about 1% y-o-y increase in revenues in Q2. Enterprises account for more than a third of Juniper’s revenues, and hence we will be closely watching the company’s performance in this segment for any signs of unexpected declines. However, the overall strengthening of the networking market is a big positive for the company whose new products have been gaining momentum in the more important service provider market – which accounts for about 65% of its total revenues. As a result, Juniper’s stock has risen almost 30% since the last earnings call and is currently trading about 10% below our $23 price estimate.

See our full analysis of Juniper Networks

Growth In Data Demand Despite Weak Macro

The positive sentiments surrounding the slow but steady recovery in network spending worldwide have been echoed by the industry heavyweight Cisco as well. The networking giant in its May earnings call, gave a bullish guidance for its next quarter revenues in an uncharacteristic departure from its usual conservative stance  – a sign that the recent recovery is likely to sustain itself in the coming quarters.

As optimism in the macro-environment slowly returns, we expect service providers to start investing more heavily in their network infrastructure. The recent macro-economic concerns have only resulted in longer project cycles and the extension of delivery timelines from customers. Capital spending on networks and hence Juniper’s revenues should once again grow as economic conditions stabilize. This is because the macro concerns have had little impact on data demand which has continued to remain strong driven by the key trends of mobile Internet and cloud computing. Specifically, mobile data traffic has grown exponentially with the proliferation of mobile devices such as smartphones, e-readers and tablets. According to a recent Cisco VNI report, mobile data traffic grew 70% in 2012 and is expected to grow at a CAGR of about 65% over the next five years. ((Global Mobile Data Traffic Forecast Update, 2012–2017, Cisco, February 6th, 2013))

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 and AT&T contributing about 10% each. The reliance on these big-ticket customers is, however, also a concern as we have come to see with AT&T, which recently lowered its CapEx guidance for the next two years.

Disciplined Growth In Operating Margins

Apart from the revenue gains, Juniper is performing well at managing expenses well to improve margins. The March quarter’s NON-GAAP operating margins were up over 370 basis points y-o-y, to about 15.7%. The guidance for Q2 is also a strong 17.5%, an improvement of about 250 basis points over the same period last year. A big portion of the rising operating margins is coming from its services division where gross margins have been improving on greater efficiency in customer support and service delivery. The ongoing restructuring will also result in cost savings of about $150 million for the full year 2013, as compared to 2012. At the same time, Juniper is seeing increased traction for its new products, especially in routing that should help product gross margins improve further.

However, the impact would be gradual since new products generally need time in the market to start having a meaningful impact. The initial signs are however good with the new products such as P4000, PTX and QFabric already accounting for more than 10% of its product revenues last quarter. Juniper is also confident of achieving a quarterly revenue run rate of $150 million for the new products by the end of the year, which is more than 75% ahead of the current run rate.

Understand How a Company’s Products Impact its Stock Price at Trefis