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3 Communication Stocks Set to Ride on Fiber & Cloud Thrust

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The Zacks Communication - Components industry appears well poised to benefit from healthy demand trends and an increasing user propensity to stay abreast of the latest digital innovations. However, volatility in raw material prices due to elevated customer inventory levels, high capital expenditures for infrastructure upgrades, margin erosion, geopolitical conflicts and raging wars have dented the industry’s profitability.

Nevertheless, Arista Networks, Inc. (ANET - Free Report) , Harmonic Inc. (HLIT - Free Report) and Ooma, Inc. (OOMA - Free Report) are likely to gain as demand for scalable infrastructure for seamless connectivity rises with the wide proliferation of IoT, widespread fiber densification, increased cloud adoption and accelerated 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 incorporated into equipment and facilities, and subsequently utilized by service providers to build networks for end users. Their 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 the Communication Components Industry?

Cloud & Fiber Architecture Gaining Prominence: The firms are likely to benefit from a software-driven, data-centric approach that helps customers build their cloud architecture and enhance the cloud experience. The industry participants are well-poised for growth in data-driven cloud networking business with proactive platforms and predictive operations. 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 loops, which are required by wireless service providers to deploy the 5G network.

Depleting Profit Margins: Although supply chain woes have declined progressively, the industry is facing a dearth of chips, which are the building blocks of various equipment used by telecom carriers. Moreover, high raw material prices due to the Middle East tensions, the prolonged Russia-Ukraine war and the consequent economic sanctions against the Putin regime have affected the operation schedule of various firms. High technological obsolescence of most products has escalated operating costs, while high customer inventory levels and a conservative approach toward placing orders for high-value items remain headwinds.

Network Convergence: With operators moving toward converged or multi-use network structures, combining voice, video and data communications into a single network, the industry is increasingly developing solutions with steady R&D investments to support wireline and wireless network convergence. These investments are likely to help minimize service delivery costs to adequately support broadband competition and expand rural coverage and wireless densification. The industry players have enabled enterprises to rapidly scale communications functionalities to a vast range of applications and devices with easy-to-use software application programming interfaces. The firms support high user volumes without affecting deliverability and cost-effectively eliminate performance degradation.

Solid Demand Trends: As both consumers and enterprises are using networks more extensively, there is tremendous demand for quality networking components. Additionally, data consumption patterns are changing, with a growing propensity to consume more video content, creating the need for faster data transfer. Since optical networks are more efficient and most existing networks are copper-based, the demand for optical solutions is particularly strong. The industry firms offer several products focused on the data center, with a typical portfolio consisting of optical fiber, hardware, cables and connectors, enabling them to meet the evolving customer requirements and bridge the digital divide across the United States.

Zacks Industry Rank Indicates Bullish Trends

The Zacks Communication - Components industry is housed within the broader Zacks Computer and Technology sector. It carries a Zacks Industry Rank #93, which places it in the top 37% 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 solid 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.

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 Outperforms S&P 500, Sector

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

The industry has rallied 52.3% over this period compared with the S&P 500 and sector’s rise of 17% and 22.6%, 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 5.42X compared with the S&P 500’s 6.18X. It is also below the sector’s trailing 12-month P/B of 6.64X.

Over the past five years, the industry has traded as high as 5.5X, as low as 2.02X and at the median of 3.47X, as the chart below shows.

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

3 Communication Components Stocks to Watch

Arista: Santa Clara, CA-based Arista provides cloud networking solutions for data centers and cloud computing environments. It offers one of the broadest product lines of data center and Ethernet switches and routers in the industry. The stock has gained 87.2% over the past year. The Zacks Consensus Estimate for the current and next fiscal earnings has been revised 23.4% and 28.5% upward, respectively, over the past year. It has a long-term earnings growth expectation of 15.7% and delivered an earnings surprise of 15.4%, on average, in the trailing four quarters.

Arista continues to benefit from the expanding cloud networking market, driven by strong demand for scalable infrastructure. In addition to high capacity and easy availability, its cloud networking solutions promise predictable performance and programmability that enable integration with third-party applications for network management, automation and orchestration. Arista currently sports a Zacks Rank #1 (Strong Buy). You can see the complete list of today’s Zacks #1 Rank stocks here.

Price and Consensus: ANET

Harmonic: Headquartered in San Jose, CA, Harmonic provides video delivery software, products, system solutions and services worldwide. With more than three decades of experience, it has revolutionized cable access networking via the industry's first virtualized cable access solution, enabling cable operators to more flexibly deploy gigabit Internet service to consumers' homes and mobile devices.

Harmonic, carrying a Zacks Rank #2 (Buy), delivered an earnings surprise of 5.6%, on average, in the trailing four quarters. The company is likely to benefit from its new product launches that help operators simplify their fiber upgrades, enabling them to accelerate the time to market of high-speed fiber broadband by integrating several functionalities into one module.

Price and Consensus: HLIT

Ooma: 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 platforms serve as a hub for seamless communications and networking infrastructure applications. It delivered an earnings surprise of 8.9%, on average, in the trailing four quarters.

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. This Zacks Rank #2 stock has a VGM Score of B.

Price and Consensus: OOMA

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