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Bear of the Day: Netgear (NTGR)

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It’s not a great time to be in the network equipment business. The US-China trade dispute threatens to increase prices for firms which are heavily dependent on Chinese manufacturing and a threatened global economic slowdown would mean significantly reduced demand for finished products.

Netgear (NTGR - Free Report) now finds itself stuck between the proverbial rock and hard place, with planned tariffs potentially increasing the cost of its products – manufacturing of which is outsourced to several other companies, primarily in China and Vietnam – just as demand for its commercial networking equipment seems likely to wane.

The products Netgear makes for the home consumer market tend to sell consistently, regardless of economic conditions, but the businesses that purchase more expensive switches, network appliances and storage solutions tend to ramp up their spending during boom times and cut back sharply when times are tougher.

The e-commerce industry in particular tends to need additional network equipment immediately when sales are booming and is generally not price sensitive because they can make back the investment quickly by having fast and reliable networks. In lean times, however, there’s generally plenty of network capacity and delaying the purchase of upgraded equipment.

Enterprise network equipment also typically has a usable life in excess of the length of time the owner needs it. It becomes obsolete before it wears out. Unfortunately this means it’s a cash cow for equipment resellers who can repurpose pre-owned equipment from large businesses as an upgrade for smaller businesses at a much lower cost than buying new.

Netgear shares are down more than 35% so far in 2019, badly lagging the S&P 500 and the Hardware industry. A bottom line earnings beat in July breathed a bit of new life into the shares, but when you break down the report, it wasn’t really all that strong.

Quarterly net revenue of $231M was the lowest level in more than two years. Operating margin of just 4.4% was more than 50% lower than the previous three quarters and though net earnings of $0.28/share exceeded already-lowered expectations, that number was also down more than 50% than the previous quarter.

Each of Netgear’s three global regions showed a decline in revenue. The Americas were down 9.9%, Europe, Middle East and Africa were down 10.6% and Asia Pacific was down 6.3%.

Overall sales in 2019 are expected to be $1.05B - 25% lower than the previous year - and 2020 is only a bit better at $1.08B.

Negative momentum on analyst revisions earn Netgear a Zacks Rank #5 (Strong Sell).

Investors in the Network Hardware space would be wise to consider Extreme Networks (EXTR - Free Report) instead, a Zacks Rank #1 (Strong Buy).

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