The Zacks Communication - Components industry appears to be mired in a challenging macroeconomic environment and uncertain business conditions despite a gradual revival in post-pandemic market conditions. In addition, high capital expenditures for infrastructure upgrades, margin erosion, inflationary pressures, supply-chain disruptions driven by the prolonged Russia-Ukraine war and high customer inventory levels have dented the industry’s profitability.
Nevertheless, Arista Networks, Inc. ANET, Corning Incorporated GLW and TESSCO Technologies Incorporated TESS might benefit in the long run as demand for scalable infrastructure rises for seamless connectivity with the wide proliferation of IoT, fiber densification 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. The 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: The industry is continuously facing a shortage of chips, which are the building blocks for various equipment used by telecom carriers. Uncertainty regarding chip shortage and supply-chain disruptions leading to a dearth of essential fiber materials, shipping delays and shortages of other raw materials are likely to affect the expansion and rollout of new broadband networks. Extended lead times for basic components are also likely to adversely impact the delivery schedule and escalate production costs. Moreover, high raw material prices due to the prolonged Russia-Ukraine war and the consequent economic sanctions against the Putin regime have affected the operation schedule of various firms. Although various steps have been taken to address the global shortage of semiconductor chips and devise ways to increase domestic production, the demand-supply imbalance has crippled operations and largely affected profitability due to inflated equipment prices.
Fiber Densification: 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. Higher utilization of advanced routers to deliver data packets from one network to another is gaining prominence, while state-of-the-art antenna systems remain essential architectural components for seamless connectivity. Telecom firms are aiding their customers to move away from an economy-of-scale network operating model to demand-driven operations by offering easy programmability and flexible automation. The industry participants enable customers to manage the exponential bandwidth costs effectively through steady investments in state-of-the-art technologies. These include DOCSIS (Data Over Cable Service Interface Specification), DSL (Digital Subscriber Line) and Next Generation PON (Passive Optical Network) platforms that enable service providers to deliver the highest bandwidth to subscribers across any physical connection.
Margin Woes Persist: The exponential growth of mobile broadband traffic and home Internet solutions has resulted in a massive demand for advanced networking architecture, forcing service providers to spend more on routers and switches as carriers aim to upgrade their networks. Further, there is a continuous need for network tuning and optimization to maintain superior performance standards, creating demand for state-of-the-art wireless products and services. 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. In addition, high customer inventory levels and a conservative approach for indenting high-value items remain other headwinds.
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 #182, which places it among the bottom 27% 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, 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 gained 2% over this period against the S&P 500 and sector’s decline of 5.4% and 7.8%, 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 3.3X compared with the S&P 500’s 5.59X. It is also below the sector’s trailing-12-month P/B ratio of 5.42X.
Over the past five years, the industry has traded as high as 4.31X, as low as 1.99X and at the median of 3.13X, as the chart below shows.
Trailing 12-Month price-to-book (P/B) Ratio
3 Communication Components Stocks to Keep a Close Eye on
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 datacenter and campus 1/2.5/5/10/25/40/50/100/400 Gigabit Ethernet switches and routers in the industry. The stock has gained 29% over the past year. The Zacks Consensus Estimate for the current and next fiscal earnings has been revised 38.2% and 34.9% upward, respectively, over the past year. It has a long-term earnings growth expectation of 14.2% and delivered an earnings surprise of 14.2%, on average, in the trailing four quarters.
Arista continues benefiting 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. The company’s product portfolio facilitates the implementation of high-performance, highly scalable and appropriate solutions for every environment. Arista currently carries a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.
Price and Consensus: ANET
Corning: New York-based Corning is a leading innovator in the glass substrate industry. The company produces advanced glass substrates that are used in a large number of applications across multiple markets. Multiple factors should drive Corning’s fiber optic solutions business over the next several years, primarily the increasing use of mobile devices that require efficient data transfer and efficient networking systems. 5G, broadband and cloud computing continue to drive strong growth across the Optical Communications segment.
Corning, carrying a Zacks Rank #3 (Hold), delivered an earnings surprise of 3.4%, on average, in the trailing four quarters. It has a VGM Score of B. Corning’s capability positions it to better serve the secular increase in demand for LCD panels. The company’s fusion technology reduces glass thickness, enabling panel manufacturers to do away with thinning costs that are usually necessary for making slimmer, lighter and more power-efficient consumer devices.
Price and Consensus: GLW
TESSCO: Headquartered in Hunt Valley, MD, TESSCO offers base station infrastructure products, including base station antennas, cable and transmission lines, and network systems products, such as fixed and mobile broadband radio equipment and security and surveillance products. It offers products to the industry’s top manufacturers in mobile communications, Wi-Fi, wireless backhaul and related products. With more than three decades of experience, it delivers complete end-to-end solutions to the wireless industry. The Zacks Consensus Estimate for the current and next fiscal earnings has been revised 29.1% and 120.8% upward, respectively, over the past year.
With the completion of the sale of the retail business, the company is likely to be better focused and more growth-oriented, even as the industry grapples with various supply constraints. TESSCO has multiple growth drivers over the next several years and is poised to benefit from the faster rollout of 5G and the increasing prevalence of IoT. Focus on pricing, stringent cost-cutting initiatives and an emphasis on high-margin products are additional tailwinds. It has a VGM Score of B. This Zacks Rank #3 stock delivered an earnings surprise of 107%, on average, in the trailing four quarters.
Price and Consensus: TESS
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