Is Ericsson Overvalued After A 100% Rebound?

Ericsson stock (NASDAQ: ERIC) lost more than 30% – dropping from $9 at the beginning of the year to nearly $6 in late March – then spiked 100% to around $12 now. But that means the stock has not only recovered, but it is 30% higher than where it started the year while the broader market is flat!

Why is Ericsson outperforming the broader market? Ericsson primarily operates in the telecom industry and the telecom business has remained relatively immune from the impact of Covid-19. This is also evident from Ericsson’s peer, Nokia’s stock price movement, which has also outperformed the broader market. Nokia and Ericsson are the leaders in the 5G technology space and as demand for 5G services increases, the market revised their expectations-helping the stock outperform. Moreover, the multi-billion dollar Fed stimulus provided a floor, and the stock recovery owes a part to that.

But has the stock run its course or is there room for growth? It seems to have run its course. Trefis estimates Ericsson’s valuation to be around $11 per share – about 5% below the current market price -based on upcoming triggers explained below and one major risk factor.

The first trigger we see is cost-cutting efforts helping Ericsson’s net margins rise to close to 6% for 2020 with the figure further improving to 8% in 2021. Ericsson’s margins have been volatile (-12% in 2017, then 1% in 2019), so where is this sudden, predictable cost saving from? The absence of restructuring charges and improved gross margin resulting from higher hardware margin is likely to result in significant cost savings for the company.

The second trigger is relatively stable Ericsson’s revenues over the year. We expect the company to report $24.3 billion in revenues for 2020 – slightly higher to the figure the company reported in 2019. While companies in other industries are fighting for survival, Ericsson’s resilient business model will help the company grow its revenue despite the pandemic. Our forecast stems from the belief that the company’s business will remain immune from the outbreak of coronavirus as sales of 5G equipment in North America and Asia will remain strong. After all, the company’s networks division accounts for nearly 70% of total revenues. Overall, we see the company reporting an EPS in the range of $0.45 for the FY 2020.

Thereafter, Ericsson’s revenues are expected to increase to $25.3 billion in FY2021, mainly due to steady growth across all operating segments. Further, the net income margin is likely to improve due to improved profitability and lower restructuring costs, leading to an EPS of $0.61 for FY2021. 

Finally, how much should the market pay per dollar of Ericsson’s earnings? Well, to earn close to $0.61 per year from a bank, you’d have to deposit about $75 in a savings account today, so about 110x the desired earnings. At Ericsson’s current share price of roughly $11, we are talking about a P/E multiple of almost 19x. And we think a figure closer to 18x will be appropriate.

That said, telecom hardware is a slow-growing business. Growth looks less promising, and long-term prospects are less than rosy. What’s behind that?

The economic downturn could cause significant losses for businesses, and the companies might delay the adoption of 5G technology and hardware upgradation. This could result in sizable losses for Ericsson, as the company derives a bulk of its revenues from its networks division. Moreover, the company’s network business has been its largest growth driver while its digital services has been struggling. Further, we believe the market has already priced Ericsson’s growth and risk drivers and the company’s stock looks marginally overvalued at its current levels.

While Ericsson stock looks fully valued, could investing in debt-laden, down-but-not-out companies yield large upside post-Covid? Find out more in our analysis: The Leveraged 5: AAL, CTL, COTY, OXY, HOG.

See all Trefis Price Estimates and Download Trefis Data here

What’s behind Trefis? See How It’s Powering New Collaboration and What-Ifs For CFOs and Finance Teams | Product, R&D, and Marketing Team