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Communication Components Industry Outlook Appears Murky

Supriyo Bose

The Zacks Communication - Components industry primarily comprises companies that provide diverse telecom products and services for the development of scalable network architecture, demand-driven video solutions and broadband access equipment. These include various building blocks such as small cells, routers and antennas that are incorporated into equipment and facilities, and are 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, cable and DSL modems, EMTAs (Embedded Multimedia Terminal Adapter), gateways and set-top boxes.

Some firms within the industry also offer cloud networking and virtualization solutions for data centers and cloud computing environments. A few industry participants even provide glass substrates that are commonly found in LCD TVs, notebooks and flat-panel desktop PC monitors, ceramic substrates for mobile, emission control systems, filter plates for genomics, centrifuge tubes and laboratory filtration products. In addition, some firms offer digital platform for hands-free communication via secure text messaging, alert and alarm management that effectively solve healthcare communication and workflow challenges.

Here are the three major themes in the industry:

•    Telecom service providers are increasingly leaning toward fiber optic cable in order to meet the burgeoning demand for cloud-based business data and video-streaming services by individuals. Moreover, fiber-optic cable network is vital for backhaul and last mile local loop, which are required by wireless service providers for deployment of 5G network. Fiber networks are also essential for the growing deployment of small cells that bring the network closer to the user, and supplement macro networks to provide extensive coverage. Higher utilization of advanced routers to deliver data packets from one network to another is gaining prominence, while state-of-the-art antenna systems remain essential architectural components for seamless connectivity. However, the industry appears mired in various challenges in the aftermath of the trade war and trade restrictions imposed on several products and services.

•    The industry participants are transforming the entertainment experience through a holistic approach to content delivery in order to help providers anticipate demand for more personalized, relevant and mobile experiences. Moreover, the firms offer a variety of pathways for delivering services through a combination of network-based video transcoding, packaging, storage and compression technologies required to deliver new IP video formats and home gateways to connected devices inside and outside home. Some firms are also benefiting from the expanding cloud networking market, primarily driven by strong demand for scalable infrastructure, which has become necessary for new applications and services. Apart from delivering high capacity and availability, cloud networking promises predictable performance along with programmability that enables integration with third-party applications for network, management, automation, orchestration and network services.

•    Consumer demand for faster Internet speeds with more capacity continues to grow at an escalating rate, primarily driven by increasing consumption of video. The wide proliferation of cloud networking solutions is further resulting in increased storage and computing on a virtual plane. Since both consumers and enterprises are using the network more, there is tremendous demand for quality networking equipment. Moreover, demand for faster data transfer is fueling growth of optical networks. The industry participants provide the technology to enable customers manage this exponential bandwidth-development cost effectively through steady investments in state-of-the-art technologies. These include DOCSIS (Data Over Cable Service Interface Specification), DSL (Digital Subscriber Line) and Next Generation PON (Passive Optical Network) platforms that enable service providers to deliver the highest bandwidth to subscribers across any physical connection. Further, some firms within the industry are benefiting from innovations in the glass substrate market, enabling panel manufacturers to do away with thinning costs that are usually necessary for making slimmer, lighter and more power-efficient consumer devices.

Overall, despite inherent growth factors, the industry faces challenges due to the tariff war and trade restrictions imposed on various products.

Zacks Industry Rank Indicates Bearish Prospects

The Zacks Communication - Components industry is housed within the broader Zacks Computer and Technology sector. It carries a Zacks Industry Rank #177, which places it at the bottom 31% 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 encouraging 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 2019 have remained flat since year-end 2018, the same for 2020 has declined 21.3% over the same period.

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

The Zacks Communication - Infrastructure industry has outpaced the broader Zacks Computer and Technology sector as well as the S&P 500 composite over the past year, largely due to healthy demand trends.

The industry has rallied 2.4% over this period against the S&P 500 and sector’s fall of 1% and 8.2%, respectively.

One Year Price Performance

Industry’s Current Valuation

On the basis of trailing 12-month price-to-book (P/B) ratio, the industry is currently trading at 2.86X compared with the S&P 500’s 3.78X. It is also below the sector’s trailing-12-month P/B of 4.32X.

Over the past five years, the industry has traded as high as 3.39X and as low as 1.02X and at the median of 1.45X, as the chart below shows.

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

Bottom Line

With gradual deployment of 5G technologies, fiber optics and massive proliferation of data traffic, the industry has inherent growth potential. However, issues related to the trade war has clouded the near-term growth prospects and the industry outlook appears bleak.

One of the stocks in the space currently sports a Zacks Rank #1 (Strong Buy). You can see the complete list of today’s Zacks #1 Rank stocks here. We are also presenting a stock with Zacks Rank #2 (Buy) and a couple of stocks with Zacks Rank #3 (Hold) that are well positioned to grow.

Knowles Corporation (KN): Headquartered in Itasca, IL, this communication components manufacturer has gained a modest 7.8% in the past year. The Zacks Consensus Estimate for current fiscal-year earnings for this Zacks Rank #1 stock has moved up 8.6% in the past year.

Price and Consensus: KN

Altice USA, Inc. (ATUS): Based in Long Island City, NY, this communication components manufacturer has gained a healthy 22.4% in the past year. This Zacks Rank #2 stock has a trailing four-quarter average positive earnings surprise of 127.9%.

Price and Consensus: ATUS

Acacia Communications, Inc. (ACIA): Founded in 2009 and headquartered in Maynard, MA, this communication components manufacturer has gained a solid 44.3% in the past year. The Zacks Consensus Estimate for current fiscal year and next fiscal-year earnings for this Zacks Rank #3 stock has moved up 117.1% and 115.2%, respectively, over the past year.

Price and Consensus: ACIA

Arista Networks Inc. (ANET): Headquartered in Santa Clara, CA, this Zacks Rank #3 communication components manufacturer has long-term earnings growth expectation of 19.1%. The Zacks Consensus Estimate for the current fiscal-year earnings has moved up 11.1% in the past year.

Price and Consensus: ANET

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