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3 Communication Stocks Set to Beat the Chip Shortage Blues

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The Zacks Communication - Components industry appears to be mired in uncertainties due to supply chain disruptions and chip shortage, with large-scale investments to support the transition to 5G, high R&D and raw material costs further eroding margins. Also, tense Sino-U.S. trade relations and the resurgence of newer coronavirus variants have rendered a grim picture for the future.

Nevertheless, Harmonic Inc. (HLIT - Free Report) , Ooma, Inc. (OOMA - Free Report) and KVH Industries, Inc. (KVHI - Free Report) might gain in the long run as pent-up demand for scalable infrastructure rises for seamless connectivity amid the wide proliferation of IoT led by a faster pace of 5G deployment.

Industry Description

The Zacks Communication - Components industry primarily comprises companies that provide diverse telecom products and services to develop scalable network architecture, demand-driven video solutions and broadband access equipment. These include various building blocks such as small cells, routers and antennas that are incorporated into equipment and facilities and subsequently utilized by service providers to build networks for end users. The product portfolio encompasses optical and copper connectivity products, hybrid fiber-coaxial equipment, edge routers, metro Wi-Fi, storage and distribution equipment for cable TV operators, modems, EMTAs (Embedded Multimedia Terminal Adapter), gateways, set-top boxes, analog and digital microphones, audio processors, glass substrates for LCD TVs and notebooks, ceramic substrates for mobile and laboratory filtration products.

What's Shaping the Future of Communication Components Industry

Chip Shortage Hurting Operations: With the exponential growth of mobile broadband traffic and home Internet solutions owing to the increasing work-from-home trend, digital sustainability has become the norm of the day and user demand for coverage speed and quality has increased manifold. This has resulted in a massive demand for advanced networking architecture, in turn, forcing service providers to spend more on routers and switches as carriers aim to upgrade their networks to support the surge in home data traffic. Further, there is a continuous need for network tuning and optimization to maintain superior performance standards, creating demand for state-of-the-art wireless products and services. However, uncertainty regarding the continued chip shortage and supply-chain disruptions extending beyond semiconductors have crippled the manufacturing operations of most firms, leading to curtailed production schedules. This, in turn, has led to acute demand-supply imbalance, as the industry faces a dearth of essential fiber materials, shipping delays and shortages of containers and other raw materials, affecting the expansion and rollout of new broadband networks. Extended lead times for basic components have negatively impacted the delivery schedules and escalated costs, prompting several industry groups to urge the government to take immediate corrective actions.

Margin Woes Persist as Demand-Driven Business Model Gains Steam: Fiber networks are essential for the growing deployment of small cells that bring the network closer to the user and supplement macro networks to provide extensive coverage. Telecom service providers are increasingly leaning toward fiber optic cable to meet the burgeoning demand for cloud-based business data and video-streaming services by individuals. Moreover, the fiber-optic cable network is vital for backhaul and last-mile local loop, which are required by wireless service providers for the deployment of the 5G network. Higher utilization of advanced routers to deliver data packets from one network to another is gaining prominence while state-of-the-art antenna systems remain essential architectural components for seamless connectivity. The telecom firms are aiding their customers to move away from an economy-of-scale network operating model to demand-driven operations by offering easy programmability and flexible automation. The convergence of network technologies requires considerable investments from both traditional carriers (telecom and cable) and cloud service providers. Although these investments will eventually help minimize service delivery costs to support broadband competition and wireless densification, short-term profitability has largely been compromised.

Scalable Infrastructure Leading to Seamless Connectivity: Consumer demand for faster Internet speeds with more capacity continues to grow at an escalating rate, primarily driven by the increasing consumption of videos. The wide proliferation of cloud networking solutions is further resulting in increased storage and computing on a virtual plane. As both consumers and enterprises use the network, there is tremendous demand for quality networking equipment. Moreover, the demand for faster data transfer is fueling the growth of optical networks. The industry participants provide the technology that enables customers to manage this exponential bandwidth development cost-effectively through steady investments in state-of-the-art technologies. These include DOCSIS (Data Over Cable Service Interface Specification), DSL (Digital Subscriber Line) and Next Generation PON (Passive Optical Network) platforms that enable service providers to deliver the highest bandwidth to subscribers across any physical connection. Further, some firms offer a variety of pathways for providing services through a combination of network-based video transcoding, packaging, storage and compression technologies required to deliver new IP video formats and home gateways to connected devices inside and outside the home.

Zacks Industry Rank Indicates Bleak Prospects

The Zacks Communication - Components industry is housed within the broader Zacks Computer and Technology sector. It carries a Zacks Industry Rank #208, which places it among the bottom 18% of more than 250 Zacks industries.

The group’s Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates grim prospects. Our research shows that the top 50% of the Zacks-ranked industries outperform the bottom 50% by a factor of more than 2 to 1. The industry’s positioning in the bottom 50% of the Zacks-ranked industries is a result of a negative earnings outlook for the constituent companies in aggregate.

Before we present a few communication component stocks that are well-positioned to outperform the market based on a strong earnings outlook, let’s take a look at the industry’s recent stock market performance and valuation picture.

Industry Lags S&P 500, Sector

The Zacks Communication - Infrastructure industry has lagged the S&P 500 composite and the broader Zacks Computer and Technology sector over the past year.

The industry has gained 15% over this period compared with the S&P 500 and sector’s rise of 27.6% and 29%, respectively.

One Year Price Performance

Industry's Current Valuation

On the basis of the trailing 12-month price-to-book (P/B), the industry is currently trading at 3.63X compared with the S&P 500’s 7.03X. It is also below the sector’s trailing-12-month P/B ratio of 9.84X.

Over the past five years, the industry has traded as high as 4.21X, as low as 1.31X and at the median of 2.86X, as the chart below shows.

Trailing 12-Month price-to-book (P/B) Ratio

3 Communication Components Stocks to Keep a Close Eye on

Harmonic Inc.: Headquartered in San Jose, CA, Harmonic is a leading provider of virtualized cable access and video delivery solutions that enable media companies and service providers to offer ultra-high-quality video streaming and broadcast services to consumers globally. The stock has gained 64.2% in the past year. The Zacks Consensus Estimate for the current and next fiscal earnings has been revised 23.1% and 8.5% upward, respectively, over the past 90 days.

The Video business of Harmonic is benefiting from 5G reclamation projects and Satellite to Terrestrial IP fiber migrations. The company is making steady progress with the CableOS product with more than 3.9 million cable modems operating in the field and 68 commercial deployments. Management was also able to effectively navigate the supply chain constraints with a commanding lead in the virtualization of cable  TV broadband along with a solid base for software and video subscription business. Harmonic sports a Zacks Rank #1 (Strong Buy). You can see the complete list of today’s Zacks #1 Rank stocks here.

Price and Consensus: HLIT

Ooma Inc.: Headquartered in Sunnyvale, CA, Ooma offers cloud-based communications solutions, smart security and other connected services. Its smart software-as-a-service and unified-communications-as-a-service (UCaaS) platforms serve as a hub for seamless communications and networking infrastructure applications. The stock has gained 24.5% in the past year. The Zacks Consensus Estimate for the current and next fiscal earnings has been revised 87% upward over the past year.

Ooma’s focus on small business customers with simple, easy-to-use interfaces that can be implemented quickly without IT support for an integrated business connectivity solution is likely to drive healthy growth momentum. Its low-cost fixed line that reportedly offers faster emergency access services is expected to gain traction while increased penetration within enterprise markets with customized offerings is likely to bear fruit. Ooma currently has a Zacks Rank #3 (Hold).

Price and Consensus: OOMA

KVH Industries, Inc.: Based in Middletown, RI, KVH Industries is a leading provider of mobile connectivity and inertial navigation systems for defense and commercial applications. This Zacks Rank #2 (Buy) stock delivered an earnings surprise of 50%, on average, in the trailing four quarters.

KVH Industries is driving growth and margin expansion through new product introduction and subscriber migration to High-Throughput Satellites. It aims to make decisive inroads into the autonomous transportation markets with a strong balance sheet position and zero debt. If KVH Industries manages to effectively mitigate the supply chain woes, there could be further room for cash flow expansion.
Price and Consensus: KVHI

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