Is Brocade a Buy Ahead of Earnings?

NEW YORK (TheStreet) -- Network equipment maker Brocade (BRCD) will be reporting first-quarter earnings on Thursday and I will be paying close attention to see if it presents sufficient justification to remain on my watch list. For as much as I have been an unabashed cheerleader of Cisco (CSCO) and the rest of the networking sector, Brocade has always been a name I have kept at arm's length.

Mainly, the stock has always been too expensive for me. I have never been able to justify paying for an equity that trades almost three times the price-to-earnings ratio of the market leader, Cisco, while also lagging in both operating and gross margins. That never really sat well with me.
Brocade

However I am more than willing to give the company its share of credit for not only having managed a poor market perception, but also for navigating through a very difficult financial period -- somewhat evident in its latest earnings report.

The company's numbers were far from stellar as it demonstrated flat revenue on a year-over-year basis while dropping 10% sequentially. But I walked away from the disappointing declines still wanting to give the company the benefit of the doubt, understanding that it did beat consensus estimates on both year-over-year declines as well as its end of range, while showing decent profitability.

Expectations for the Quarter

For the coming quarter analysts are expecting earnings per share of 8 cents -- which would represent a decline of 11% from the same period a year ago. Although the company has been performing relatively well, it has seen a reduction in analysts' estimates over the past three months -- previously from 9 cents.

For the year, analysts are projecting net income of 43 cents per share -- representing an increase of almost 40% from last year. Revenue is projected to arrive at $541.4 million, a decline of 1.6% annually from $560 million. I think these are pretty modest numbers for a company the caliber of Brocade, a company that has shown a considerable amount of improvement since the beginning of the year.

I don't envision a scenario where the company does not at least meet expectations -- particularly considering the recent impressive numbers reported by both Cisco and Hewlett-Packard ( HPQ). The level of optimism increases a bit more when one factors in that the entire networking sector continues to outperform and exceed analysts' expectations -- exemplified by recent reports from the likes of F5 ( FFIV) and Juniper ( JNPR).

Moving Forward

Its expensive valuation notwithstanding, there are still some appealing qualities to Brocade -- like the fact that it modeled Cisco's aggressiveness by acquiring one of its rivals in Foundry Networks in 2008. With the move, management sought to broaden the company a little bit more and place less dependency on its storage business and the effort appears to be paying handsomely.

Another advantage is being able to sell networking gear to its existing customer base as a means of providing one-stop-shop services. This strategy too has now proven to have worked, or is, at the very least, currently working. Furthermore, the company continues to be underestimates when it comes to discussing its preparation for the cloud.

To that end, Brocade has taken a slightly different approach toward organization and deployment. The company understands that networks must be cloud-optimized at every critical point because companies will define not only the application performance but more importantly, the end-user experience. Though it lacks the history of both Cisco and HP, it does have a strong tradition in both data and storage networking.

Bottom Line

As corporate IT spending fully recovers, there is a chance that Brocade will begin to see its stock price appreciate a bit more. But it stands to reason that as both Cisco and HP maintain their path toward resurgence, they will add increased pressure on smaller names such as Brocade.

So far the company has shown that it is up to the challenge. Hopefully that will become evident when it reports its numbers. From an investment standpoint, until its P/E drops a bit more, I will keep it arm's length.

At the time of publication, the author held no positions in any of the stocks mentioned.

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