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, Arista Networks, Inc. ANET, AudioCodes Ltd. AUDC and Turtle Beach Corporation HEAR might benefit 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 Equipment Prices: Although supply chain woes have declined progressively, the industry is facing a dearth of chips, which are the building blocks of various equipment used by telecom carriers. Moreover, high raw material prices due to the Israel-Hamas conflict, the prolonged Russia-Ukraine war and the consequent economic sanctions against the Putin regime have affected the operation schedule of various firms. The demand-supply imbalance has crippled operations and largely affected profitability due to inflated equipment prices.
Cloud Focus, Fiber Densification: The firms are likely to benefit from a software-driven, data-centric approach that helps customers build their cloud architecture and enhance the cloud experience. The industry participants are well-poised for growth in data-driven cloud networking business with proactive platforms and predictive operations. Fiber networks are essential for the growing deployment of small cells that bring the network closer to the user and supplement macro networks to provide extensive coverage. Telecom service providers are increasingly leaning toward fiber optic cable to meet the burgeoning demand for cloud-based business data and video streaming services by individuals. Moreover, the fiber-optic cable network is vital for backhaul and last-mile local loop, which are required by wireless service providers to deploy the 5G network.
Waning Profits: 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 Trends
The Zacks Communication - Components industry is housed within the broader Zacks Computer and Technology sector. It carries a Zacks Industry Rank #195, which places it among the bottom 23% 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 bleak 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, Lags Sector
The Zacks Communication - Infrastructure industry has outperformed the S&P 500 composite but lagged the broader Zacks Computer and Technology sector over the past year.
The industry has rallied 46% over this period compared with the S&P 500 and sector’s rise of 24.5% and 53.1%, 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 4.32X compared with the S&P 500’s 6.06X. It is also below the sector’s trailing 12-month P/B of 6.52X.
Over the past five years, the industry has traded as high as 4.42X, as low as 2.02X and at the median of 3.35X, as the chart below shows.
Trailing 12-Month Price-to-Book (P/B) Ratio
3 Communication Components Stocks to Watch
Arista: Santa Clara, CA-based Arista provides cloud networking solutions for data centers and cloud computing environments. It offers one of the broadest product lines of data center and Ethernet switches and routers in the industry. The stock has gained 103.4% over the past year. The Zacks Consensus Estimate for the current and next fiscal earnings has been revised 25.2% and 24.2% upward, respectively, over the past year. It has a long-term earnings growth expectation of 19.8% and delivered an earnings surprise of 12%, on average, in the trailing four quarters.
Arista continues to benefit from the expanding cloud networking market, driven by strong demand for scalable infrastructure. In addition to high capacity and easy availability, its cloud networking solutions promise predictable performance and programmability that enable integration with third-party applications for network management, automation and orchestration. Arista currently carries a Zacks Rank #3 (Hold). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.
Price and Consensus: ANET
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, as well as 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 likely to benefit from its continued focus on high-margin businesses. This Zacks Rank #3 stock has a long-term earnings growth expectation of 24.8% and delivered an earnings surprise of 14%, on average, in the trailing four quarters.
Price and Consensus: AUDC
Turtle Beach: Headquartered in White Plains, NY, it develops, commercializes and markets gaming headset solutions for various platforms, including video game and entertainment consoles, handheld consoles, personal computers, tablets and mobile devices under the Turtle Beach brand. The Zacks Consensus Estimate for the current and next fiscal earnings have been revised 36.9% and 40% upward, respectively, since April 2023. The stock has gained 40.4% over the past year.
Turtle Beach is well-positioned to benefit from quality products and enjoys a solid foothold in its served markets. Its headsets are suited for learning and working remotely via video or audio conferencing. Turtle Beach is likely to benefit in the near term as retailers return to normalized inventory replenishment along with a solid video game release schedule and normalized console availability. This Zacks Rank #3 stock has a long-term earnings growth expectation of 16%.
Price and Consensus: HEAR
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