3 Communication Stocks Likely to Surpass Industry Conundrums

The Zacks Communication - Components industry appears mired in raw material price volatility due to elevated inventory levels amid a challenging macroeconomic environment, uncertain market conditions and geopolitical conflicts. Moreover, high capital expenditure for infrastructure upgrades for 5G deployment, inflated equipment costs, supply chain adversities albeit at diminishing pace and margin erosion have dented the industry’s profitability.

Nevertheless, Harmonic Inc. HLIT, Ooma, Inc. OOMA and AudioCodes Ltd. AUDC are likely to gain in the long run as demand for scalable infrastructure for seamless connectivity rises with the wide proliferation of IoT, fiber densification, transition to cloud and accelerated 5G rollout.

Industry Description

The Zacks Communication - Components industry primarily comprises companies that provide diverse telecom products and services to develop scalable network architecture, demand-driven video solutions and broadband access equipment. These include various building blocks such as small cells, routers and antennas incorporated into equipment and facilities, and 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, modems, EMTAs (Embedded Multimedia Terminal Adapter), gateways, set-top boxes, analog and digital microphones, audio processors, glass substrates for LCD TVs and notebooks, ceramic substrates for mobile and laboratory filtration products.

What's Shaping the Future of the Communication Components Industry?

Inflated Operating Costs: Although supply chain woes have declined progressively, the industry is facing a dearth of chips, which are the building blocks of various telecom carrier equipment. Moreover, high raw material prices due to Middle East tensions, the prolonged Russia-Ukraine war and the consequent economic sanctions against the Putin regime have affected the operation schedule of various firms. High technological obsolescence of most products has escalated operating costs, while high customer inventory levels and a conservative approach toward placing orders for high-value items remain headwinds.

Network Convergence: The industry players have enabled enterprises to rapidly scale communications functionalities to a vast range of applications and devices with easy-to-use software application programming interfaces. The firms support high user volumes without affecting deliverability and cost-effectively eliminate performance degradation. The industry is benefiting from a software-driven, data-centric approach that helps customers build their cloud architecture and enhance the cloud experience. The industry participants are well-positioned for growth in the data-driven cloud networking business with proactive platforms and predictive operations. 

Short-Term Profitability Compromised: The exponential growth of mobile broadband traffic and home Internet solutions has resulted in massive demand for advanced networking architecture, forcing service providers to spend more on routers and switches as carriers aim to upgrade their networks. Although higher infrastructure investments will eventually help minimize service delivery costs to support broadband competition and wireless densification, short-term profitability has largely been compromised. High technological obsolescence of most products has escalated operating costs with steady investments in R&D. High customer inventory levels and a conservative approach toward placing orders for high-value items remain other headwinds for the industry. Extended lead times for basic components are expected to adversely impact the delivery schedule and escalate production costs.

Demand Erosion: Efforts to offset substantial capital expenditure for upgrading network infrastructure by raising fees have reduced demand, as customers prefer to switch to lower-priced alternatives. In addition, the latent tension between the United States and China, relating to trade restrictions imposed on the sale of communication equipment to firms based in the communist country, has dented the industry’s credibility, leading to a loss of business. The industry is battling hard-to-mitigate operating risks stemming from volatility in demand, an unpredictable business environment and challenging geopolitical scenarios.

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 #165, which places it among the bottom 33% 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 grim prospects. Our research shows that the top 50% of the Zacks-ranked industries outperform the bottom 50% by a factor of more than 2 to 1. 

Before we present a few communication component 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 S&P 500, Sector

The Zacks Communication - Infrastructure industry has outperformed the S&P 500 composite and the broader Zacks Computer and Technology sector over the past year.

The industry has rallied 34.1% over this period compared with the S&P 500 and sector’s rise of 9.2% and 7.2%, respectively.

One-Year Price Performance

Industry's Current Valuation

On the basis of the trailing 12-month price-to-book (P/B), the industry is currently trading at 3.11X compared with the S&P 500’s 7.81X. It is also below the sector’s trailing 12-month P/B of 8.63X.

Over the past five years, the industry has traded as high as 4.02X, as low as 1.72X and at the median of 2.75X, as the chart below shows.

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

3 Communication Components Stocks to Watch

Harmonic: Headquartered in San Jose, CA, Harmonic provides video delivery software, products, system solutions and services worldwide. With more than three decades of experience, it has revolutionized cable access networking via the industry's first virtualized cable access solution, enabling cable operators to more flexibly deploy gigabit Internet service to consumers' homes and mobile devices. 

Harmonic, carrying a Zacks Rank #3 (Hold), delivered an earnings surprise of 67.9%, on average, in the trailing four quarters. The company is likely to benefit from innovative product launches that simplify the entire process of media delivery for premium video streaming and broadcasting, enabling service providers to optimize efficiency and flexibility while reducing operational costs. It has a VGM Score of A. You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Price and Consensus: HLIT

Ooma: Headquartered in Sunnyvale, CA, Ooma offers cloud-based communications solutions, smart security and other connected services. Its smart software-as-a-service and unified-communications-as-a-service platforms serve as a hub for seamless communications and networking infrastructure applications. It delivered an earnings surprise of 18%, on average, in the trailing four quarters. This Zacks Rank #3 stock has a VGM Score of A. 

Ooma’s focus on small business customers with simple, easy-to-use interfaces that can be implemented quickly without IT support for an integrated business connectivity solution is likely to drive healthy growth momentum. Its low-cost fixed line that reportedly offers faster emergency access services is expected to gain traction, while increased penetration within enterprise markets with customized offerings is likely to bear fruit.

AudioCodes: Incorporated in 1992 and headquartered in Lod, Israel, AudioCodes offers advanced communications software, products and productivity solutions for the digital workplace. Its product portfolio includes session border controllers, life cycle management solutions, VoIP network routing solutions, media gateways and servers, multi-service business routers, IP phone solutions and value-added applications, and professional services.  

AudioCodes is likely to benefit from the secular tailwinds related to IP-based communications. It aims to leverage its long-term partnership with Microsoft to further strengthen its market position. AudioCodes is also expected to gain from its continued focus on high-margin businesses. This Zacks Rank #3 stock delivered an earnings surprise of 0.4%, on average, in the trailing four quarters. It has a VGM Score of A. 

Price and Consensus: AUDC

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Harmonic Inc. (HLIT): Free Stock Analysis Report
 
AudioCodes Ltd. (AUDC): Free Stock Analysis Report
 
Ooma, Inc. (OOMA): Free Stock Analysis Report

This article originally published on Zacks Investment Research (zacks.com).

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