ALCATEL-LUCENT: NEUTRAL, TP €3.75 - Operating performance masked by the deal;TP cutto €3.75
Slightly lowering EBIT estimates, maintain Neutral. Post Q1 results, we leave our revenue estimates for 2015/2016 largely unchanged at €14.45bn/€14.75bn (+10%/+2% yoy), but our EBIT estimates see downward revision of 6%/2% to €1.02bn/€1.24bn due to higher opex (FX and reinvestments) partly offset by slightly higher GM. This drives EBIT margins of 7.1%/8.4% in 2015/2016 (vs. our earlier estimate of 7.5%/8.6%). Post our recent downgrade of NOK and ALU given concerns around complexity of merger, we remain Neutral on ALU.
Strong pick up in Core through the year. While start to Core Networking's performance in 2015 has been slower than expected, the company reiterated its FY target for the business (€7bn of sales with 12.5% OM). This would be driven by strong pick up in Terrestrial (Verizon contract ramp in 2H15), Routing (share gains in Core Routing) and upswing in Submarine. As such, we model €6.9bn of sales for Core in 2015 with 11.7% OMs, but believe that half of this EBIT weakness (vs. company's guidance) may be compensated by better performance in Access (mainly Wireless).
Opex going up due to FX, not entirely unexpected. Given ALU has around 60% of its opex base in USD or USD denominated currencies, we expected opex to go up yoy in 2015 despite the ongoing cost cutting program, but commentary around reinvestments in R&D and channels is new. As such, we believe opex to grow from €3.79bn in 2014 to €4.20bn in 2015 (18% appreciation in USD/EUR) but then decline by ~€200mn from that base given ongoing cost cutting plans. This leads to our estimate of €3.98bn of clean opex for 2015 (+5% yoy).
Still on track for FCF positive for full year 2015. In spite of slightly lower EBIT, we still believe ALU remains on track for being FCF positive for full year. We assume €40mn of FCF for 2015, which should improve to around €600mn in 2016 driven by lower cash restructuring and growth in EBIT.
Lowering TP to €3.75. We derive our TP for ALU using 0.55 exchange ratio for Nokia shares post the deal completion. Using our TP of €6.80 for Nokia, this gives us fair value of €3.75 for Alcatel-Lucent (vs. €4.00 previously).