Shares of hardware networking tech stocks Nokia (NOK) and Arista Networks (ANET) have been decimated recently. While Nokia stock is trading 47% below its 52-week high, ANET stock is trading 41% below its 52-week high.
Let’s have a look at the factors that impacted these companies and whether they are bargains at the current level.
Nokia has underperformed tech stocks in 2019
Similar to most other tech stocks, Nokia had a strong start to 2019. The stock rose close to 13% in January, but everything has been downhill since then. Concerns over a sluggish global economy and a slowdown in enterprise tech spending have exacerbated the situation.
Nokia stock has fallen over 30% since its third-quarter results were released last month. The company reported sales of 5.68 billion euros in Q3 2019, compared to sales of 5.458 billion euros in Q3 2018.
Although Nokia ended Q3 with sales growth and positive free cash flow, investors were concerned over the company’s gross margin. Nokia’s third-quarter gross margin was impacted by product mix and high costs associated with its first generation of 5G products.
Further, the company experienced profitability challenges in China and pricing pressure in its early-stage 5G deals. Although the company expects to mitigate these issues as the 5G rollout begins on a larger scale, it would also mean increasing investments in 5G.
Nokia aims to invest in the digitization of internal processes and in its enterprise and software business to drive margins higher. It revised its financial forecasts for 2019 and 2020 and expects to improve the bottom line substantially by 2021.
For 2019, Nokia forecast a non-IFRS operating margin of 7.5%–9.5%, well below its prior forecast of 9%–12%. In 2020, it expects an operating margin of 8%–11%, below the prior forecast of 12%–16%.
Nokia cuts dividend payments
While poor profit margins are a cause for concern, what really rattled investors was Nokia’s decision to roll back its dividend payments. The company stated that it wants to use cash to increase its 5G investments in 5G and other strategic verticals.
Nokia paid an annual dividend of $0.22 per share, which indicated a payout ratio of 87%. This suggests that the firm would have no cash left to distribute due to lower operating margins. Nokia stated that it would restart its dividend payments once its cash balance reaches 2 billion euros.
Nokia’s poor quarterly results and a grave forecast resulted in several analyst downgrades. According to multiple reports from TheFly:
- Credit Suisse downgraded Nokia to “neutral” from “market perform” and reduced its price target from $6.38 to $4.27.
- Barclays downgraded Nokia to “equal-weight” from “overweight” with a price target of 3.50 euros.
- DZ Bank downgraded the stock to “hold” from “buy” with a price target of 3.90 euros.
- JPMorgan downgraded Nokia to “neutral” from “overweight” and reduced its price target from $7.50 to $4.20.
- Raymond James downgraded NOK stock to “outperform” from “strong buy” with a reduced price target of $5 from $7.50.
Arista Networks led the decline among networking tech stocks
Shares of Arista Networks (ANET) were on an absolute tear in the first four months of 2019. ANET stock gained a staggering 65.5% between January and April 2019. However, concerns over Arista’s revenue growth drove its stock lower over the last few months. Peer stocks Cisco Systems (CSCO) and Hewlett Packard Enterprise (HPE) have returned 13% and 28.5%, respectively, year-to-date.
In early November, ANET reported its third-quarter results. ANET’s Q3 sales reached $654.4 million, and its earnings per share were $2.69. Analysts expected ANET to post sales of $653.25 million and EPS of $2.41 in the third quarter.
While the third-quarter results were above consensus estimates, ANET’s poor guidance sent the stock crashing. The company confirmed that lower spending from a “cloud titan customer” would result in soft Q4 revenue. ANET forecast sales of $540 million–$560 million in the fourth quarter, which was significantly below the consensus estimate of $686.2 million.
The cloud customer is most likely Microsoft, which accounted for more than a quarter of its sales in 2018. ANET was soon downgraded by several investment banks. The company is now expected to report its first year of revenue decline in 2020. Analysts expect its sales to fall 0.3% to $2.41 billion in 2020.
Can ANET and NOK outperform tech stocks in 2020?
Most tech stocks are trading close to record highs. The Technology Select Sector SPDR Fund (XLK) has returned almost 40% in 2019 and might move lower in a sell-off. However, are Nokia and ANET stocks attractive to contrarian investors? Have these two stocks bottomed out?
Analysts have a 12-month average target price of $214 for Arista Networks, which is 11.5% above its current price. Analysts expect Nokia’s stock to reach $4.80 by November 2020, which is 37% higher than the current trading price of $3.50.