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Interim Headwinds Mar Communication Infrastructure Outlook

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The Zacks Communication - Infrastructure industry comprises companies that provide various infrastructure solutions for the core, access and edge layers of communication networks. These firms support mission-critical, high bandwidth applications like cloud-based computing, video, mobile and machine-to-machine connectivity. Leveraging proprietary modeling and simulation techniques to optimize networks, the firms offer high-speed network access solutions for use across Internet protocol (IP), asynchronous transfer mode and time division multiplexed architectures in both wireline and wireless network applications to leading global telecom operators, multi-system operators and numerous enterprise customers. Their product portfolio encompasses optical fiber and twisted pair structured cable solutions, infrastructure management hardware and software, network racks and cabinets, and fiber-to-home equipment like hardened connector systems, couplers and splitters and hardened optical terminating enclosures.

In addition, some firms provide materials for cellular base station sites and connectivity; indoor, small cell and distributed antenna wireless systems; and wireless network backhaul planning and optimization products and services to improve cellular coverage and capacity in high-traffic areas and in places difficult for networks to penetrate. Certain firms within the industry even provide data center infrastructure solutions that include colocation space and power, and interconnection services to various enterprise, cloud, carrier and content customers.

Here are the three major themes in the industry:

•    With rapid growth in video and other bandwidth-intensive applications, the industry participants are making considerable investments in LTE, broadband and fiber in order to provide additional capacity and ramp up Internet and wireless networks. As a result, these companies are rapidly transforming from legacy copper-based telecommunications firms to technology powerhouses with capabilities to meet the growing demand for flexible data, video, voice and IP solutions. At the same time, the industry participants are focusing on leveraging wireline momentum, expanding media coverage, improving customer service and achieving a competitive cost structure to generate higher average revenue per user and attract customers. Increasing demand for reliable access and fast-data services is expected to expand customer base.

•    The impending 5G boom is likely to propel the industry to newer heights. The success of 5G hinges on substantial investments to upgrade infrastructure in the core fiber backhaul network to support anticipated growth in data services. With operators moving toward converged or multi-use network structures, combining voice, video and data communications into a single network, the industry is developing solutions to support wireline and wireless network convergence, which will be essential for the success of 5G. Although these investments will eventually help minimize service delivery costs to adequately support broadband competition, rural coverage and wireless densification, short-term profitability is likely to get eroded. The industry's near-term prospects also remain vulnerable to a number of factors like risks of disruption from extreme weather and the growing menace of cyber-attacks. Efforts to build resilient infrastructure facilities to withstand natural catastrophes have further increased operating costs. Moreover, simmering tensions between the United States and China related to trade restrictions imposed on the sale of communication equipment to Chinese firms have dented the industry's credibility and led to loss of some businesses. However, there appears to be some light at the end of the tunnel with the resumption of the negotiation process.

•    In order to enable the service providers to accelerate time to market, reduce costs and improve customer satisfaction, some industry participants offer a complete portfolio of maintenance, turnkey network implementation, maintenance, solutions integration and managed services. The network implementation services offer a full spectrum of services related to engineering (pre-construction), installation/turn-up (construction) and provisioning (post-construction), partnering with customers to tailor a program to each specific service delivery need. This holistic growth model augurs well for the overall development of the industry and enables service providers to continue rolling out avant-garde solutions to meet the rising demand for bandwidth.

Overall, despite favorable long-term growth potential, the industry appears to be challenged by near-term headwinds, portraying grim prospects.

Zacks Industry Rank Indicates Gloomy Prospects

The Zacks Communication - Infrastructure industry is housed within the broader Zacks Computer and Technology sector. It carries a Zacks Industry Rank #166, which places it at the bottom 35% 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 bleak prospects. Our research shows that the top 50% of the Zacks-ranked industries outperforms 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 negative earnings outlook for the constituent companies in aggregate. Looking at the aggregate earnings estimate revisions, it appears that analysts are losing confidence in this group’s earnings growth potential. In the past year, the industry’s earnings estimates for the current fiscal have declined 6.5%.

Before we present a few communication infrastructure 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 Underperforms Sector and S&P 500

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

The industry has declined 19% over this period against the S&P 500 and sector’s rise of 6.6% and 7.2%, respectively.

One Year Price Performance

Industry’s Current Valuation

On the basis of trailing 12-month enterprise value-to EBITDA (EV/EBITDA) ratio, which is the most appropriate multiple for valuing telecom stocks, the industry is currently trading at 11.28X compared to the S&P 500’s tally of 11.46X. It is below the sector’s trailing 12-month EV/EBITDA of 11.71X.

Over the past five years, the industry has traded as high as 15.18X and as low as 7.78X and at the median of 11.46X, as the chart below shows.

Trailing 12-Month Enterprise Value-to EBITDA (EV/EBITDA) Ratio

Bottom Line

Although the industry appears mired in various operational woes at the moment, it is likely to benefit from healthy long-term growth dynamics once the market stabilizes and the effect of the capital investments percolates.

None of the stocks in the space currently carries either a Zacks Rank #2 (Buy) or sports a Zacks Rank #1 (Strong Buy). You can see the complete list of today’s Zacks #1 Rank stocks here.

We are presenting three stocks with a Zacks Rank #3 (Hold) that are well positioned to grow.

Calix, Inc. (CALX - Free Report) : Headquartered in San Jose, CA, this communications infrastructure provider has long-term earnings growth expectation of 6%. The Zacks Consensus Estimate for current and next fiscal-year earnings has moved up 16.7% and 940%, respectively, in the past year.

Price and Consensus: CALX

Zayo Group Holdings, Inc. ZAYO: This Boulder, CO-based communication infrastructure stock has gained 47.3% year to date. The Zacks Consensus Estimate for current-year earnings has been revised 4.2% upward over the past year.

Price and Consensus: ZAYO

Bandwidth Inc. (BAND - Free Report) : Headquartered in Raleigh, NC, this communications infrastructure provider has gained 129.1% in the past year. The Zacks Consensus Estimate for current fiscal-year earnings has moved up 28.4% over the past 90 days.

Price and Consensus: BAND

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