Juniper Earnings Preview: Routers, Switches In Focus

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Juniper Networks

Juniper (NYSE:JNPR) is scheduled to announce its Q4 2014 results on Tuesday, January 27. The company reported a mixed set of results in the previous quarter, with sales declining by 5% year-over-year (y-o-y) to $1.13 billion on account of sluggish demand from service providers in the U.S., even as adjusted operating margins (non-GAAP) improved 170 basis points to 21.5% over the prior year quarter. In terms of business divisions, Routing and Security registered double digit declines over the same period last year, with Switching being the only division reporting growth (5%). In terms of geographies, the company recorded growth only in the Americas (2.6%), with Asia-Pacific sales declining by a massive 28% y-o-y. [1] [2]

As part of its guidance for Q4, the company stated in its Q3 earnings call that it was expecting overall revenues of $1.025-$1.075 billion, missing the analyst consensus of $1.17 billion compiled by Thomson Reuters. It cited uncertainty of demand and the timing of deals with its carrier customers in the U.S. for its cautious stance on revenue guidance. Juniper’s clients in the U.S. include wireless majors Verizon (NYSE: VZ) and AT&T (NYSE: T).

Our $25 price estimate for Juniper is currently 15% ahead of the market price.

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See our full analysis of Juniper Networks

Weak Router Sales Growth Expected

Macroeconomic concerns in the last few years 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 visible in the first half of the year when routing sales grew in high-single digits over the prior year period. However, sluggish demand from the U.S. carriers in both the core and edge router market resulted in Q3 2014 routing sales witnessing a decline of about 12% y-o-y and 14% sequentially. Since service providers account for more than two-thirds of Juniper’s revenues, any weakness in demand reflects significantly on the company’s top line performance.

In the U.S., Verizon and AT&T have been big Juniper customers, with each accounting for about 10% of Juniper’s revenues in recent years. The performance of Juniper’s new MX series of edge routers in recent quarters has been the most encouraging, given that the edge router market is by far the biggest among all router markets. However, with the company reporting weak demand in the past few months, we expect the company to report sluggish growth in edge router sales in the fourth quarter.

By our estimates, edge routers account for more than 50% of the overall market and about 70% of the service provider router market. There is still some lumpiness being seen in the order build-up for core routers, but Juniper managed to more than offset that with MX’s continued strength last quarter. According to research firm Dell’oro, demand for core routers is likely to grow in 2015 as technologies such as 100 Gigabit ethernet gain momentum. However, the service provider edge router market is likely to report only low-single digit sales growth on the back of subdued investments by service providers in their LTE backhaul networks. 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. [3]

Realigned Strategy To Boost Switching Sales

The Wireless LAN (WLAN) business is included in the company’s Switching division, which contributes over 17% of its valuation according to our estimates. Juniper’s switching business has performed well in the last few years, with sales increasing 15% and 12% y-o-y in 2013 and 2012, respectively. Juniper’s switching sales grew by 5% y-o-y to $155 million in the third quarter, driven by sustained demand for QFabric products, partially offset by a decline in sales of EX series switches and lower demand from Web 2.0 players. Growth was much lower than in the first two quarters this year, when the division reported sales growth of 25% and 46% y-o-y in Q2 and Q1, respectively.

Going forward, the company is optimistic about ramping up switching sales on account of a number of recent contract wins and their realigned switching strategy with a focus on R&D and developing new products such as the QFX5100. Moreover, 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). [4]

R&D Cost Optimization To Improve Cash Flows

Juniper has historically been an innovation-focused company, relying heavily on an expensive R&D budget to out-innovate rivals and gain market share. Its R&D costs as a percentage of revenues have generally been among the highest in the industry. Juniper’s R&D spend as a percentage of revenues of about 21-22% is about 9 percentage points higher than peers such as Cisco and F5 networks. [5] Reducing this to peer-average levels of 11-12% could drive cost savings of about $420 million in the longer run. Juniper’s plan to cut expenses by $160 million on the back of the ongoing restructuring initiatives is about 40% of that, and can be reasonably expected to be achieved in the near term.

If Juniper realizes the planned cost savings by 2015, we expect its OpEx as a percentage of gross profits to decrease from around 63% in 2013 to about 54% two years out. Consequently, its EBITDA margins would improve by almost 540 basis points (5.4%). Adjusted for taxes, this could lead to an improvement of more than $100 million in free cash flow going forward. Our current estimates assume that the company will be able to implement its planned initiatives successfully and realize the aforementioned increase in cash flows as a result.

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Notes:
  1. Press Release, Juniper, Oct 23 2014 []
  2. Q3 2014 Juniper Earnings Transcript, Seeking Alpha, Oct 23 2014 []
  3. Demand for Service Provider Routers Weakens in Third Quarter 2014, Dell’Oro, Dec 2014 []
  4. Cisco maintains 62.2 percent market share in Ethernet switch market, Fierce telecom, Aug 2013 []
  5. Elliott Management’s Perspectives on Juniper, January 13th, 2014 []