Juniper Rides Networking Market Recovery As Enterprise Stabilizes

Juniper (NYSE:JNPR) recently announced a very strong set of Q2 results, as revenues were buoyed by the ongoing recovery in network spending to exceed the high-end of its guidance by almost 5%. While the service provider market has been showing signs of strength from the past three quarters, the stabilization in the enterprise saw Juniper’s revenues climb more than 7% over the year-ago quarter. This is a big improvement since last year when revenues had declined by about 4% y-o-y. A part of the out-performance was due to an earlier-than-anticipated recognition of revenue from the federal government. But Juniper’s guidance of almost 4% y-o-y growth in revenues for the next quarter shows that the overall recovery in the networking market seems to be well and truly underway – a sentiment that was echoed by Cisco in its last earnings call as well.

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. Juniper said that its new products saw a sequential increase in revenues and are on track to achieve a quarterly revenue run rate of $150 million by the end of the year. Juniper’s stock has risen more than 30% in the past three months, and is currently trading about 10% below our slightly revised $23.50 price estimate.

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Growth In Data Demand Despite Weak Macro

The positive sentiment 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 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 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. In the U.S., where service provider demand is on the rise, Verizon and AT&T are big Juniper customers with each accounting for about 10% of Juniper’s revenues. 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 also managing expenses well to improve margins. The June quarter’s NON-GAAP operating margins were up almost 400 basis points y-o-y, to about 19%. The guidance for Q3 is also a strong 19.5%, an improvement of about 260 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 at least 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, when they would account for almost 20% of total revenues by our estimates.

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