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Wall Street, California | SECTOR SPOTLIGHT

Telecom Equipment Makers Flying High

Even Asia has failed to slow these stocks' sizzling growth. But at lofty average P/Es, can it continue?


Telecommunications equipment companies produce the guts that make telephones, mobile phones, fax machines, Internet networks and other systems move and switch phone calls and data at blindingly fast speeds.

And moving things ahead at a rip-roaring pace is also the perfect metaphor for the equipment makers' stocks this year.

A quick look at the price-to-earnings multiples in the accompanying chart illustrates the point: These stocks are among the market's top guns. The sector's 37% surge so far this year is fifth-highest among the 89 groups that make up the Standard & Poor's 500 index, though the stocks have pulled back in tandem with other technology shares (and the broader market) in recent sessions.

The telecom equipment stocks are up sharply in response to the companies' sizzling gains in revenues and earnings over the last two years, propelled by a boom in capital spending by the Baby Bell regional phone companies and by the burgeoning number of long-distance carriers.

Even Southeast Asia's current economic problems haven't slowed them much, said analyst Tim Luke of Lehman Bros. "The key drivers for the equipment guys are China and, to a lesser extent, Japan," he said. Those regions, along with North America and Europe, have been robust enough "to offset the slowdown in Southeast Asia."

Cases in point: Mobile-telephone systems giants LM Ericsson of Sweden (ticker symbol: ERICY) and Nokia of Finland (NOK/A), which garner 20% or more of their total revenue from Asia, "have still managed to post strong growth," Luke said.


But has the easy money been made in these stocks? After all, the shares are carrying price-to-earnings ratios (based on their expected 1998 earnings) that are 50% or more above the overall market average P/E. If the companies' profits dip even a bit below expectations, their shares could get hammered by unforgiving investors--as is happening now with many computer-related stocks.

And there's plenty of opportunity to come up short. Competition is fierce as the players jostle to offer the latest technologies to telecommunications providers, and to invade turfs that have been dominated for years by one or two companies.

There are also the proposed mergers among the giant telecommunications companies--the deal by Pacific Bell parent SBC Communications Inc. (SBC) to buy Ameritech Corp. (AIT) for $56 billion is just one--which would reduce the number of potential customers for the equipment firms.

Indeed, shares of Ciena Corp. (CIEN) recently tumbled after the maker of phone network gear said it's unsure when orders from WorldCom Inc. (WCOM) will resume. WorldCom had suspended orders until it closes its $37-billion purchase of MCI Communications Corp. (MCIC).


Ciena holders were already nervous because the company this year has faced growing competition from phone network giants Lucent Technologies Inc. (LU)--the equipment arm that AT&T Corp. spun off in 1996--and Northern Telecom Ltd. (NT).

Those two also are encroaching on the turf of Cisco Systems Inc. (CSCO), the powerhouse in moving data across the Internet and in other computer network systems. Lucent and Northern Telecom have recently unveiled products for transmitting voice over data networks and are aggressively peddling those products to telecommunications carriers looking to move voice and data on routes outside their conventional phone lines.

Yet despite all these trends, Wall Street still likes a selected number of the equipment companies and believes their growth will remain steady enough to justify the prices these stocks now command.

Take Cisco, a stock that's soared a stunning 87% a year on average since 1990 as the company exploited and fostered the Internet's soaring popularity. Despite that remarkable feat and its growing battle with the likes of Lucent, George Kelly of Morgan Stanley, Dean Witter, Discover & Co. still has a "strong buy" on the stock because he expects Cisco to keep posting compounded annual earnings growth of 30% for the next five years.

He's also set a price target of $90 a share for Cisco over the next 12 months; the stock currently trades at $73.56 on Nasdaq.

Lehman's Luke also likes Cisco, noting that "as a dominant sector leader [with] expanding share in a growing market, Cisco remains our sole buy recommendation in the data-networking industry."

Meanwhile, Lucent--which on Monday quickly settled a strike with its two major unions (story, D14)--has been on a tear to the point that some analysts believe the stock has gotten ahead of itself, even if the company's fundamentals remain bullish. Philip Sirlin of Schroder & Co. recently downgraded Lucent to "hold" simply because of the stock's run-up.


Others, though, are urging investors to keep buying Lucent, in good part because they see the pending telecom mergers not as reducing the number of Lucent customers, but as a potential way to expand the company's reach.

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