Ericsson (ERIC) Posts Huge Q3 Loss, But Sees Improvement

In its third-quarter 2017 results, Ericsson (BS:ERICAs)’s (NASDAQ:ERIC) losses widened sharply, dragged by restructuring expenses and provisions as the company struggles amid challenging market conditions and a major strategic shake-up.

The wireless communications gear maker lost money for the fourth straight quarter, as it posted non-IFRS loss of SEK 0.55 (6 cents) per share (excluding amortizations, write-downs of acquired intangible assets and restructuring charges). This is in stark contrast with earnings of SEK 0.34 recorded in the comparable quarter last year. Declining sales and shrinking margins put immense pressure on the bottom line.

The figure also compared unfavourably with the Zacks Consensus Estimate of earnings of 1 penny, marking the seventh consecutive earnings miss for this Swedish communication technology and services giant.

However, the company assured investors that it had detected signs of improvement and increased stability in product roadmaps and projects. Investors clearly still have faith in the company, as this news sent the stock soaring almost 6% at one point in pre-market trading, despite posting terrible quarterly losses.

Contracting product demand, lower software sales, and weak IT & Cloud business results pushed the company’s earnings into the red, as the Swedish firm reported a huge net loss of SEK 4.3 billion ($528.5 million), much wider than the loss of SEK 0.2 billion witnessed a year ago.

Inside the Headlines

Net sales for the quarter fell 6% year over year to SEK 47.8 billion ($5.9 billion). However, the top line beat the Zacks Consensus Estimate of $5,789 million comfortably. Weak mobile broadband market, shrinking network sales and lower investments in parts of Europe, Latin America, and the Middle East & Africa dragged down revenues.

The decline in sales was all-pervasive, with all three operating segments of the company charting decline in revenues. Lower IPR licensing revenues, in particular, were a major drag on third-quarter sales.

Ericsson Price, Consensus and EPS Surprise

Ericsson Price, Consensus and EPS Surprise | Ericsson Quote

Segmental Performance

As part of its recently announced restructuring plans, Ericsson reorganized its operations to focus on three core areas — Networks, Digital Services and the Internet of Things. The three segments which comprise the company’s reporting structure are: Networks, IT & Cloud and Media.

On a segmental basis, Networks revenues were down 4.3% year over year to SEK 35.4 billion ($4.4 billion). Persistent low investments in mobile broadband in certain markets and lower managed services sales resulted in the poor performance of this segment. The company expects China sales to slow for the segment, as the network operators in the country are slashing spending on 4G mobile networks after a substantial building spree in recent years. However, the Networks segment witnessed higher hardware capacity sales, and the Ericsson Radio System portfolio is also enjoying strong market traction.

IT & Cloud revenues fell 12% year over year to SEK 10.3 billion ($1.3 billion). Lower legacy product sales hampered the segmental performance and services performance also displayed weak numbers.

Other revenues fell 13% year over year to SEK 2 billion ($245.8 million), primarily due to continued lower sales of legacy products and weak broadcast services sales.

Ericsson’s gross margin (excluding restructuring charges) in the quarter expanded 60 basis points year over year to 25.4%. Higher software sales in the Networks unit more than offset reducing margins in the IT & Cloud business, resulted in the margin expansion.

However, Ericsson’s operating margin (excluding restructuring charges) figures were terrible -- it went down from 0.7% in the prior-year quarter to a negative 10% in the reported quarter. Operating income was affected by higher amortization of development expenses and higher hardware costs. Higher R&D expenses and significant impact from capitalization hurt the operating margins.

Restructuring Plan

Late in March, Ericsson’s new CEO — Börje Ekholm — announced a restructuring plan to cut costs and streamline the company’s focus areas, as well as explore options for the media business. Per the restructuring, Ericsson expects to take provisions, write-downs and restructuring charges this year, with most of them already booked in first-quarter 2017. Restructuring charges for the third quarter came to SEK 2.8 billion.

In the last quarterly report, Ericsson’s CEO had warned that an uncertain market could wipe out as much as SEK 5 billion ($600 million) of operating income over the next year. There is also an increased risk of market and customer project adjustments, which can have a negative impact of SEK 3-5 billion on the operating income until mid-2018.

Ericsson plans to accelerate its planned cost cuts and efficiency measures, and focus on the company’s core business of selling networking equipment prior to the expected roll-out of 5G networks.

Ericsson has identified 42 service contracts that it will exit, renegotiate or transform — a process which will help improve profitability. As of now, it has already exited or renegotiated 13 such contracts, helping boost profits. Broadly, the company plans to invest in research and development to fortify Networks business, and intends to stabilize IT & Cloud roadmaps.

Restructuring charges for 2017 are anticipated to come in the range of SEK 9-10 billion (up from previously expected range of (SEK 6-8 billion).

Liquidity

During the quarter, cash flow generated from operating activities set off the cash flow used in operating activities during the quarter. Ericsson’s net cash as of Sep 30, 2017, came in at SEK 24.1 billion ($3 billion) compared with SEK 16.3 billion a year back.

To Conclude

Ericsson projects an 8% drop in the market for radio access network equipments this year, which is worse than previously expected. Overall, the company expects the negative industry trends and business mix in mobile broadband to prevail this year as well. Europe and Latin America — the markets with the biggest impact — are expected to have an increasingly challenging investment environment.

Nevertheless, Ericsson still expects to stabilize its operations amid a difficult market next year and remains hopeful of reaching its targeted operating margin of 12% beyond 2018. Ekholm’s restructuring plan will help streamline Ericsson’s focus areas, improve profitability, and revitalize its technology and market leadership. The company also plans to explore options for the company’s media business and review low-performing contracts in its managed service business.

Whether these steps will allow Ericsson to jump back on the growth track, remains to be seen. However, as of now, we have a Zacks Rank #5 (Strong Sell) on the stock, as we are apprehensive over the effect of the restructuring and tough market conditions on the company’s profits and share price in the near term. Investors who are looking for exposure to the upcoming 5G upgrade cycle or IoT might look at players like Nokia (HE:NOKIA) Corporation (NYSE:NOK) and Cisco Systems, Inc. (NASDAQ:CSCO) .

Stocks to Consider

A better-ranked stock in the broader sector is Red Hat, Inc. (NYSE:RHT) , flaunting a Zacks Rank #1 (Strong Buy). You can see the complete list of today’s Zacks #1 Rank stocks here.

Red Hat has a robust earnings surprise history, with an average positive surprise of 7%, driven by three earnings beats over the trailing four quarters.

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SEK1 = $0.1229 (Period average from Jul 1, 2017 to Sep 30, 2017)

SEK1 = $0.1226 (as at Sep 30, 2017)