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Ericsson (ERIC) Q4 Earnings Miss Estimates, Revenues Rise Y/Y

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Ericsson ERIC reported unimpressive fourth-quarter 2019 results, wherein the top line and the bottom line missed the respective Zacks Consensus Estimate. However, both the figures improved on a year-over-year basis.

Net Income

Net income for the December quarter was SEK 4,430 million ($460.8 million) or SEK 1.33 (15 cents) per share against net loss of SEK 6,553 million or loss of SEK 1.99 per share in the prior-year quarter. The improvement was mainly driven by higher sales and lower cost of sales. The bottom line, however, missed the Zacks Consensus Estimate by a penny. For 2019, net income was SEK 2,223 million or SEK 0.67 per share against net loss of SEK 6,530 million or loss of SEK 1.98 per share in 2018. 

Ericsson Price, Consensus and EPS Surprise

Revenues

Quarterly net sales increased 4.1% year over year to SEK 66,373 million ($6,904.4 million), primarily driven by growth in the Middle East and North East Asia. As expected, the ongoing operator merger discussion led to lower sales in North America while there was growth with other North American customers. The top line, however, missed the consensus estimate of $6,954 million. For 2019, net sales increased 7.8% year over year to SEK 227,216 million.

Quarterly Segment Results

Net sales at Networks (which accounts for the lion’s share of total sales), increased 6.7% year over year to SEK 44.4 billion ($4.6 billion). The rise was driven by investments in LTE and 5G networks with strong growth particularly in Japan and Saudi Arabia. The segment’s gross margin grew to 41.1% year over year from 39.9%. Operating margin declined to 14.4% from 16.5% resulting from higher operating expenses due to increased investments in R&D for 5G and in projects for digital transformation, compliance and security. 

The company’s target for Networks is to generate an operating margin of 15-17% (excluding restructuring charges) by 2020. The acquired Kathrein antenna and filter business brings competence and capabilities to support the transformation of the antenna domain into multiple frequencies and technologies. Radios and antennas are being integrated to optimize network performance while further improving capacity and coverage for 5G.

Digital Services’ net sales increased 1.5% year over year to SEK 13.2 billion ($1.4 billion), driven by growth in Operations Support Systems, Cloud infrastructure and services. The segment’s gross margin improved to 37.2% from a negative 9.5% supported by cost reductions. In fourth-quarter 2018, gross margin had been negatively impacted by costs related to the revised Business Support Systems (BSS) strategy. Ericsson’s top priority is to continue to grow the new portfolio while turning Digital Services into a profitable business, targeting low single-digit operating margin by 2020 (excluding restructuring charges). There is a strong business momentum in the new Digital Services portfolio of 5G and cloud-native products.     

Managed Services’ net sales increased 1.4% year over year to SEK 7 billion ($0.7 billion) led by growth in project business. Gross margin grew to 14.8% year over year from 11.4% essentially as a result of efficiency gains. Operating margin improved to 4.2% from 4.1%. The company’s target for Managed Services is 5-8% operating margin (excluding restructuring charges) in 2020. Investments will be made in automation, analytics and AI-driven offerings to support 5G, IoT and cloud as well as to increase the efficiency in service delivery. 

Net sales from Other (including Emerging Business, iconectiv, Red Bee Media and Media Solutions) declined 26.1% year over year to SEK 1.7 billion ($0.2 billion), due to the 51% divestment of MediaKind. The segment’s gross margin increased to 13.4% from 9.3%.  

Other Details

Overall gross margin improved to 36.8% year over year from 25.7%, primarily driven by improvements in Digital Services. Total operating expenses were SEK 19 billion compared with SEK 18 billion in the prior-year quarter. The acquired Kathrein business added expenses of SEK 0.3 billion, while the divestment of MediaKind leases were SEK 0.1 billion in the fourth quarter, as an effect of IFRS 16 implementation.

Operating income for the quarter was SEK 6.1 billion against operating loss of SEK 1.9 billion in the year-ago quarter. It includes a positive impact from a partial release (SEK 0.7 billion) of a provision related to the resolution of the U.S. SEC and DOJ investigations. Operating income in fourth-quarter 2018 had been negatively impacted by costs to reshape the BSS strategy.

At the end of 2019, Ericsson had 78 commercial 5G agreements with communication service providers, 32 announced 5G contracts and 24 live 5G networks on four continents.

Cash Flow & Liquidity

In 2019, Ericsson generated SEK 16,873 million of cash from operations compared with SEK 9,342 million in 2018. For 2019, the company’s free cash flow (excluding M&A) was SEK 7.6 billion compared with SEK 4.3 billion in 2018.

As of Dec 31, 2019, the Swedish telecom gear maker had SEK 45,079 million in cash and equivalents with SEK 28,257 million of non-current borrowings compared with the respective tallies of SEK 38,389 million and SEK 30,870 million a year ago. Its net cash at the end of 2019 was SEK 34.5 billion compared with SEK 35.9 billion a year ago. 

Going Forward

Ericsson is on track with its 2020 and 2022 financial targets while making progress toward building a stronger company in the long term. Large 5G deployments in China are expected to begin in 2020. It has invested in R&D and supply chain capacity in order to increase market share.

The acquired Kathrein business is anticipated to have a negative impact on Networks’ margins during 2020, with a gradual improvement in the second half. The improvement in Digital Services is likely to continue but earnings will vary between quarters depending on business mix, sales seasonality and impact of the remainder of the 45 critical contracts. 

Ericsson is witnessing healthy momentum in its business, based on the strategy to increase its investments for technology leadership, including 5G. In Networks, the company’s ongoing activities are to invest in R&D to safeguard a leading product portfolio and cost leadership; increase investments in automation and serviceability driving down costs; and selectively gain market shares based on technology and cost competitiveness.

Zacks Rank & Other Stocks to Consider

Ericsson currently carries a Zacks Rank #2 (Buy). A few other top-ranked stocks in the broader industry are Sogou Inc. SOGO, Splunk Inc. (SPLK - Free Report) and Chegg, Inc. CHGG. While Sogou and Splunk sport a Zacks Rank #1 (Strong Buy), Chegg carries a Zacks Rank #2. You can see the complete list of today’s Zacks #1 Rank stocks here.

Sogou has a long-term earnings growth expectation of 20.2%.

Splunk topped earnings estimates in the trailing four quarters, the surprise being 74.3%, on average.

Chegg surpassed earnings estimates in the trailing four quarters, the beat being 49.4%, on average.

Conversion rate used:

SEK 1 = $0.104024 (period average from Oct 1, 2019 to Dec 31, 2019)

SEK 1 = $0.107004 (as of Dec 31, 2019)


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