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Bull of the Day

Brocade Communications Systems (BRCD - Snapshot Report) recently delivered its 7th consecutive positive earnings surprise as it beat on both the top and bottom lines. Although Brocade experienced a decline in revenue year-over-year, profit margins expanded and net income surged as the company focused on efficiency.

Analysts also revised their estimates significantly higher for both 2013 and 2014 after the latest beat, sending the stock to a Zacks Rank #1 (Strong Buy). Although shares of Brocade have soared the last several weeks, the valuation picture still looks very reasonable with the stock trading at 13x forward earnings.

Brocade Communications Systems supplies networking equipment and software for all types of businesses and organizations. It primarily operates in two segments:

  • Storage Area Networking (SAN), which offers Fibre Channel SAN directors, fixed form factor switches and embedded switches, host bus adapters (HBAs) and server virtualization solutions, and
  • Internet Protocol (IP) Networking, which offers modular and stackable solutions, IP routers, Ethernet switches, Ethernet fabrics, converged adapters, as well as application delivery, security and wireless solutions

Third Quarter Results

Brocade reported its fiscal 2013 third quarter results on August 13. Adjusted earnings per share came in at 15 cents, crushing the Zacks Consensus Estimate of 9 cents. It was a 25% increase over the same quarter last year. And this increase came in spite of a decline in revenue.

Net revenue fell -3% to $536.6 million, but this was still well ahead of the consensus of $524.0 million. Revenue in the SAN Products segment was down -2% while the IP Networking Products segment saw an -8% decline. Global Services, which represented 17% of total revenue inched up by 1%.

Despite the revenue decline, the adjusted gross profit margin improved 190 basis points to 65.6% due to lower spending. Meanwhile, total operating expenses declined -2%, led by a -5% decline in 'Sales & Marketing' expenses. These factors led to a 7% increase in adjusted operating income. That, along with a -23% in interest expense, led to the big jump in EPS.

Estimates Jump Higher

Analysts revised their estimates significantly higher for Brocade after the Q3 beat, sending the stock to a Zacks Rank #1 (Strong Buy) stock.

The Zacks Consensus Estimate for 2013 is now $0.59, up from $0.52 before the beat. The 2014 consensus is currently $0.62, up from $0.52 over the same period. You can see the sharp rise in estimates in the company's 'Price & Consensus' chart:

Valuation

The valuation picture for Brocade looks reasonable. Shares trade at 13x 12-month forward earnings, below its 10-year median of 15x. And its price/book value ratio of 1.6 is also below its historical median of 1.9.

The Bottom Line

Driven by a focus on efficiency, Brocade has been able to deliver strong earnings growth despite weak revenue. With rising estimates and reasonable valuation, this Zacks Rank #1 (Strong Buy) stock offers investors a lot to like.

Todd Bunton, CFA is the Growth & Income Stock Strategist for Zacks Investment Research and Editor of the Income Plus Investor service.

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