Juniper Earnings: Weak Q3 Forecast Overshadows Strong Q2 Performance

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Juniper Networks

Juniper (NYSE:JNPR) reported strong Q2 earnings, but a below expectation outlook for the third quarter brought the stock down by about 10% in intraday trading on Wednesday, July 23. In Q2, the telecom equipment manufacturer’s revenues grew 7% year-over-year (y-o-y) to $1.23 billion, matching the upper end of its guidance. Sales growth was driven by another solid performance by the routing and switching divisions, which grew 7% and 25, respectively. However, security revenue declined by over 11% y-o-y, owing to a decline in its legacy NetScreen product sales, which offset the double-digit growth in the company’s Junos Space SRX portfolio. In terms of geographies, the company recorded robust growth across regions, led by double-digit growth in the Asia-Pacific.

On the cost side, the company’s adjusted operating expenses of $515 million matched the lower end of its guidance, reflecting the successful ongoing implementation of its “Integrated Operating Plan (IOP)”, which it launched in February this year. The company stated that it had already realized annualized savings of about $100 million through certain cost management actions such as de-layering, consolidation and reduplication, which is two-thirds of its target of $160 million savings by Q1 2015. Juniper expects to incur certain restructuring expenses every quarter for the rest of this year, which is likely to impact profitability in the near term, but recurring cash savings should drive long term value in the stock.

For the third quarter, the company said that its was expecting overall revenue of $1.15-$1.2 billion, missing the analyst consensus of $1.26 billion compiled by Thomson Reuters. It cited delays in closing some deals with a couple of its key service providers in the U.S. for its lower revenue guidance. Juniper’s clients in the U.S. include wireless majors Verizon (NYSE: VZ) and AT&T (NYSE: T). [1]

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Our$28 price estimate for Juniper is about 20% ahead of the current market price.

See our full analysis of Juniper Networks

Routing Sales Growth Continues

Macroeconomic concerns in the last few years had caused project cycles to lengthen and extended the delivery timelines from customers. With macroeconomic uncertainty subsiding, service providers have started investing more heavily in their network infrastructure. Moreover, the sustained high demand for data due to the proliferation of mobile devices and high-quality video content on the web has ensured consistent capital spending on networks. This was reflected in the second quarter results, with routing sales growing 7% over the prior year quarter, similar to its growth in the first quarter this year. Sales were driven by network consolidation in wireline and wireless, as well as in the enterprise and residential services domain, in addition to increasing demand for Cloud-building and high-IQ networking products.

Service providers account for more than two-thirds of Juniper’s revenues. In the U.S., where service provider demand is on the rise, Verizon and AT&T have been big Juniper customers, with each accounting for about 10% of Juniper’s revenues in recent years. The consistent performance of Juniper’s new MX series of edge routers in recent quarters and improvement in sales of the T-series in Q2 is perhaps the most encouraging, given that the edge router market is by far the biggest among all router markets. By our estimates, edge routers account for more than 50% of the overall market and about 70% of the service provider router market. Routers account for over 40% of Juniper’s overall valuation by our estimates, and market share gains in edge routers should be the most accretive to Juniper’s value going forward.

Switching Sales On The Rise

Juniper’s switching sales grew by an impressive 25% y-o-y to about $200 million in the second quarter, driven by sustained strong demand for QFabric products. This follows the 46% y-o-y growth recorded in the business last quarter, and we identify several important trends driving this momentum.

Firstly, there is growing demand for next generation data center transformation projects, coupled with a need to deliver at a high degree of operational simplicity. Cloud-building is another domain which is driving demand as more and more enterprises look to create scalable virtual networks. In the second quarter, Juniper delivered two large cloud projects using its open source network virtualization solution, known as Contrail. One of the projects was in the Asia-Pacific region and the other was CloudWatt, the largest cloud in France. Thirdly, the rapid expansion of big data and high-quality video are driving demand for high performance 10GB/40GB Ethernet switches. Another significant driver is the growing need for open architectures and end-to-end automation. [2]

Juniper’s switching business has performed impressively in the last few years, with sales increasing 15% and 12% y-o-y in 2013 and 2012, respectively. Going forward, the introduction of new products and its ability to promote the open converged framework (OCF) concept could help Juniper gain share in the global switching market, which is currently dominated by Cisco (NASDAQ:CSCO). [3]

Juniper recently entered into a strategic agreement with WLAN provider Aruba Networks (NASDAQ:ARUN) to deliver integrated wired and wireless network solutions. Although Aruba will be the expert Wi-Fi provider in this newly formed partnership, Juniper’s WLAN business, which is a part of the Switching division, could also get a boost as the company integrates the business with its other offerings such as enterprise security and intelligent routing solutions. If the company can expand its market share from an estimated 3.2% in 2013 to about 6% by 2020, we could see a potential upside of about 7% to our price estimate for its stock.

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Notes:
  1. Q2 2014 Presentation, Juniper []
  2. Juniper Networks’ (JNPR) CEO Shaygan Kheradpir on Q2 2014 Results – Earnings Call Transcript, Seeking Alpha, July 22 2014 []
  3. Cisco maintains 62.2 percent market share in Ethernet switch market, Fierce telecom, Aug 2013 []