This makes the stock cheap, but in this case the telecommunications equipment company's stock should be avoided.
Why? Revenue and profits have been hard to come by because of prolonged weakness in the telecom equipment market combined and increased competition from Asian vendors including ZTE Corporation. Wth gross margins now heading in the wrong direction, ERIC won't see a bottom until profits stabilize.
The stock, at around $5, has lost 26% in one month and 30% in three months. Although Ericsson shares look attractive relative to its historical trading range and when paired with peers such as Nokia Corporation (NOK) - Get Report , Ericsson's business prospects are poised to get worse before they get better, if the company's guidance serves as indication.
In the three months that ended September, Ericsson suffered an 8% year-over-year decline in Global Services revenues, reaching $2.9 billion. The company was hurt by tepid professional services performance, which was further impacted by continued declines in Network Rollout business. Support Solutions revenues also suffered, falling 11% year over year to $340 million, punished by lower software licensing sales.
Beyond weakness in almost every business segment, what really spooked investors was the fact that Ericsson's third-quarter gross margin (excluding restructuring charges) contracted 560 basis points year over year to 28.3%. Amid the weak hardware and software environment, the management has looked to offset the declining top lines by cutting costs.
In this case, the fact that gross margins still compressed, not widen, suggests that the management's cost-cutting efforts have failed. Notably, it also means that Ericsson not only underinvested in growth, it might have obtained a bigger market share in businesses that produce lower profits. This means it will have to grow its Networks and mobile broadband businesses to make up the difference.
Ericsson also warned that softening U.S. contracts may adversely impact its fourth-quarter earnings. With the company expecting mobile broadband weakness to continue in the next two to three quarters, this stock is no bargain.
This article is commentary by an independent contributor. At the time of publication, the author held no positions in the stocks mentioned.