Strong routing, robust core margin, self-help on track; CL-Buy
* Source of opportunity
ALU’s 4Q14 was strong. While group revenue was in line our est./companycompiled consensus, the higher-quality Core segment saw revenue 1%/2% ahead driven by 20% yoy growth in IP Routing and 5% growth in IP Transport, in line with our view ALU can benefit from fixed-line spend, including from non-telcos. Next-gen. products were 67% of revenues (50% in 2012), while Core margins were 16% in 4Q (beating our est./cons. 14.3%/ 14.4%), chiming with our thesis of mix shift driving margin expansion and leading to a 2% clean EBIT beat. Self help is on track with ALU executing >70% of targeted cost cuts, underpinning our view of positive FCF in 2015.
* Catalyst
We remain constructive on Alcatel’s growth and margin expansion potential and view positively gross margins of 33.9% in 2014 (our est./cons 33.2%), up 3.6 pp, alongside raised 2015 gross margin guidance (>34%). We see 15% organic IP Routing and high-single-digit IP Transport growth in 4Q as evidence of traction in these segments, allowing ALU to beat consensus during 2015. Moreover, ALU indicated recent €/$ movements would provide
a significant tailwind to revenues and a slight benefit to margins. As such, we raise our 2015/16 revenue estimates by 2% and EBIT by 1%/2%, with higher gross margins (34.4%/34.9%, from 34.1%/34.4%) partially offset by
higher opex (due to FX). We will host the CEO of Alcatel at the Goldman Sachs Tech conference in San Francisco on Thursday, February 12.
* Valuation
Our 12-month price targets increase to €4.4 (ADS $5.0) from €4.2 ($4.8) based on our SOTP valuation equivalent to an unchanged 0.8x 2016E EV/sales, higher net cash, and a 1%-2% increase in revenue estimates. We remain CL-Buy given the top-quartile upside vs. EU Technology coverage.
* Key risks
Lack of progress on cost-cutting, execution, failure to gain traction with product cycles, weaker-than-expected Submarine cycle, weaker US capex.