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Near-Term Headwinds Mar Wireless Equipment Industry Outlook

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The Zacks Wireless Equipment industry primarily comprises companies that provide various networking solutions, wireless telecom products and related services for wireless voice and data communications through scalable modular platforms. The firms within this industry are driving the transition of global enterprises to smart virtual networks by creating an integrated network for all services, converging mobile and fixed broadband, IP routing and optical networks with software and services to manage them. Their product portfolio encompasses integrated circuit devices (chips) and system software for wireless voice and data communications, analog and digital two-way radio, satellite telecommunications, wireless networking and signal processing equipment and end-to-end enterprise mobility solutions. In addition, the firms provide a broad range of routing, switching and security products along with video surveillance and machine-to-machine communication components that secure VPN appliances, enable intrusion detection and thwart data theft for seamless transfer.

The industry participants facilitate users to shift their telecom networks to the latest 5G standards, including new use cases like IoT, public safety and fixed wireless access. Along with hands-on field service operations to remote network operations, the firms offer IT managed services for the management of applications and data centers, while network design and optimization services develop and expand user networks per demand. Apart from offering scalable networks that securely connect everyone and everything to the cloud, the firms help customers transform their operations and reduce the complexity of business. Some firms within the industry even provide electronic warfare, avionics, robotics, advanced communications and maritime systems to the defense industry. A few industry participants offer air traffic management solutions for the civil aviation industry and analytics for global and space situational awareness and Earth observation missions. Some notable firms within the industry are Qualcomm Incorporated (QCOM - Free Report) , Juniper Networks Inc. (JNPR - Free Report) and Motorola Solutions Inc. (MSI - Free Report) .

Here are the three major themes in the industry:

•    With the exponential growth of mobile broadband, user demand for coverage speed and quality has increased manifold. This has resulted in huge demand for advanced networking architecture, in turn, leading service providers to spend more on routers and switches. Hence, these companies are likely to benefit from the higher spending pattern among carriers to upgrade their networks to support the incremental growth in data traffic. Further, to maintain superior performance as traffic increases, there is also a continuous need for network tuning and optimization, creating demand for state-of-the-art wireless products and services. Also, the industry participants are likely to benefit from expanding media coverage, increasing demand for reliable access and fast-data services, thereby broadening customer base and translating into higher revenues for the overall industry.

•    The continued deployment of 5G technology across the globe is likely to propel the industry to newer heights. Moreover, 5G is likely to augment the scalability, security and universal mobility of the telecommunications industry, which is expected to propel the wide proliferation of IoT. The industry participants are facilitating its customers to move away from an economy-of-scale network operating model to demand-driven operations and seamlessly migrate to 5G by offering easy programmability and flexible automation through steady infrastructure investments. Although these investments will eventually help minimize service delivery costs to support broadband competition and wireless densification, short-term profitability has largely been compromised. Margins are likely to be affected by high cost level associated with the first generation 5G products, profitability challenges in China and pricing pressure in early 5G deals.

•    Majority of the industry participants offers mission-critical communication infrastructure, devices, accessories, software and services that enable its customers to run businesses with increased efficiency and safety for their mobile workforce. These systems drive demand for additional device sales, software upgrades, infrastructure overhaul and expansion, as well as additional services to maintain, monitor and manage these complex networks and solutions. The comprehensive suite of services ensures continuity and reduces risks for constant critical communications operations. However, paucity of demand due to geopolitical uncertainty and challenging macroeconomic environment has dented the margins of most industry participants. Intense price wars due to rising costs of raw materials and stiff competition have added to woes. High technological obsolescence of most products has also escalated operating costs with continuous investments in R&D.

Overall, although the industry has inherent growth potential, it appears to be mired in short-term headwinds and uncertainty, with significant capital expenditures and price wars eroding margins.

Zacks Industry Rank Indicates Bleak Prospects

The Zacks Wireless Equipment industry is housed within the broader Zacks Computer and Technology sector. It carries a Zacks Industry Rank #196, which places it at the bottom 23% 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 discouraging 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 faith in this group’s earnings growth potential. While the industry’s earnings estimates for the current year have decreased 10.3% over the past year, the same for 2021 has declined 33.9%.

Before we present a few wireless equipment 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 Sector, Trumps S&P 500

The Zacks Wireless Equipment industry has lagged the broader Zacks Computer and Technology sector, but surpassed the S&P 500 composite over the past year.

The industry has gained 24.6% over this period compared with the S&P 500 and sector’s rally of 23.8% and 33%, 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 23.28X compared with the S&P 500’s 12.38X. It is also above the sector’s trailing-12-month EV/EBITDA of 12.71X.

Over the past five years, the industry has traded as high as 25.55X and as low as 10.1X and at the median of 15.8X, as the chart below shows.

Trailing 12-Month enterprise value-to EBITDA (EV/EBITDA) Ratio

Bottom Line

The industry is likely to benefit from increased 5G deployment and massive proliferation of data traffic in the long run. However, large-scale investments to support the transition to 5G, high R&D costs, escalated raw material costs and latent threat of re-imposition of tariff war regime have clouded the near-term prospects of the industry.

Two stocks in the space currently have a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank(Strong Buy)stocks here.

Viasat, Inc. (VSAT - Free Report) : Founded in 1986 and headquartered in Carlsbad, CA, this wireless equipment manufacturer has gained 11.5% in the past year. The Zacks Consensus Estimate for current-year earnings has moved up 105.7% in the past year.

Price and Consensus: VSAT

Ericsson (ERIC - Free Report) : Founded in 1876 and headquartered in Stockholm, Sweden, this wireless equipment manufacturer has gained 18.8% in the past two years. The Zacks Consensus Estimate for current-year earnings has moved up 27.9% in the past year.

Price and Consensus: ERIC

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

PC-Tel, Inc. (PCTI - Free Report) : Founded in 1994 and headquartered in Bloomingdale, IL, this wireless equipment manufacturer has gained an impressive 70.5% in the past year. The Zacks Consensus Estimate for current-year earnings for this stock has moved up 450% in the past year.

Price and Consensus: PCTI

Ubiquiti Inc. (UI - Free Report) : Headquartered in New York, this wireless equipment manufacturer has gained 62.1% in the past year. The Zacks Consensus Estimate for current-year earnings has jumped 56.6% in the past year.

Price and Consensus: UI

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