Investors building a 5G portfolio should look no further than with Ericsson (NYSE:ERIC). The company’s profitability rose in all segments and at levels not seen since 2006. Fortunately, Covid-19 did not harm its business.
By holding the slow-moving, low volatility Ericsson stock, patient investors will earn a decent long-term return.
Ericsson Stock Near Highs
Markets tried to pull Ericsson below the $11 range in Sept. The bearishness ended after the company posted results on Oct. 21. Sales rose 7% compared to last year, thanks primarily to 5G sales in Mainland China. Whereas other mega-cap network suppliers failed to crack this market, Ericsson is thriving. Its gross margin rose to 43.1%, up from 37.7% Y/Y.
Sales from the Networks division increased by 6% Y/Y. Excluding restructuring charges, the operating margin topped 22.7%.
On its conference call, CEO Ekholm said that the company expects momentum from its North American market continuing into 2021. The gross margin will also improve as it adjusts to declining markets such as in Europe. Apple’s (NASDAQ:AAPL) launch of the 5G iPhone is a positive catalyst in the consumer space. Ericsson’s CEO thinks that strong iPhone sales will drive demand for its network equipment.
Investors could buy shares of Ericsson and pay a price-to-earnings of no more than 25 times. Its forward P/E is in the mid-teens multiple. By comparison, Apple stock trades at a P/E approaching 40 times and a forward P/E of around 30 times.
Readers may build a 5-year discounted cash flow EBITDA Exit model. The table below is a set of metrics that may best represent Ericsson’s fair value:
|Discount Rate||8.0% – 7.0%||7.50%|
|Terminal EBITDA Multiple||9.0x – 11.0x||10.0x|
|Fair Value||$13.71 – $16.26||$14.97|
The company’s 5G portfolio is ahead of the competition. Investors are overlooking its strength, which suggests the stock is worth more than the fair value calculated above. For example, independent firms looked at its Intellectual Property Rights (IPR). They believe it will be a key contributor to its earnings. The patents also add tremendous value to Ericsson’s research and development.
To monetize its IPR, Ericsson will flex its strength by leveraging them in discussions with those who need it.
The continued market share growth is a positive catalyst that will support its revenue growth. And even though its customers like to maintain vendor diversity, Ericsson offers lower operating expenses and ultimately lower total cost of ownership for its solutions.
Embracing Open RAN (O-RAN) positions the company for future software revenue growth. CEO Ekholm does not expect O-RAN will contribute to the bottom line in the 2021-22 timeframe. Still, it will have a positive impact on its business model. And when the technology ultimately shifts, as it always does in the telecom industry, Ericsson will maximize the O-RAN opportunity.
Increasing R&D investments will accelerate its growing portfolio of products. Conversely, its legacy portfolio is falling faster than the company expected. Overall, short-term performance may suffer as sales volume comes in lower than expected. In the next few quarters, software sales will have a bigger positive impact on results. This suggests that Ericsson’s stock will continue its uptrend that began in March.
Ericsson managed the heavy competition in the 5G space effectively. It is benefiting from the healthy competition is thriving in a very healthy ecosystem. At its modest valuation on a P/E basis, the stock is attractive for value investors seeking a 5G investment. Continue holding this stock and adding aggressively to the position if the stock happens to stumble again. The entry point rarely comes and when it does, it does not stay on sale for very long.
Disclosure: On the date of publication, Chris Lau did not have (either directly or indirectly) any positions in the securities mentioned in this article.