Ericsson's (ERIC) Q4 Marks Fifth Straight Quarter of Loss

In fourth-quarter 2017, Ericsson’s ERIC losses widened sharply year over year. The bottom line was dragged down by restructuring expenses and provisions as the company struggled in the face of challenging market conditions and a major strategic shake-up.

The wireless communications gear maker lost money for the fifth straight quarter, as it posted non-IFRS loss of SEK 1.19 (1.4 cents) per share (excluding amortizations, write-downs of acquired intangible assets and restructuring charges). This is in stark contrast with earnings of SEK 0.62 recorded in the comparable quarter last year. Declining sales and severely shrinking margins put immense pressure on the bottom line.

The figure also compared unfavourably with the Zacks Consensus Estimate of earnings of 5 cents, marking the eighth consecutive earnings miss for this Swedish communication technology and services giant.

Contracting product demand, lower networks sales, and increased R&D expenses pushed the company’s earnings into the red, as the Swedish firm reported a massive net loss of SEK 18.9 billion ($2,271.8 million), much wider than the loss of SEK 1.6 billion witnessed in the prior year.

For the full year, the company reported a net loss of SEK 35.1 billion ($4.2 billion), in stark contrast to the year-ago tally of net income of SEK 1.9 billion.

Inside the Headlines

Net sales for the quarter fell 12% year over year to SEK 57.2 billion ($6,875 million). The top line also missed the Zacks Consensus Estimate of $7,074 million. Weak mobile broadband market, shrinking network sales and earlier completion of larger mobile broadband projects in South East Asia, India, the Middle East & Africa dragged down revenues. The decline in sales was all pervasive, with all four operating segments of the company charting decline in revenues.

For 2017, the company posted sales of SEK 201.3 billion ($24.2 billion), down from SEK 222.6 billion generated in 2016.

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 into four segments, which now comprise the company’s reporting structure: Networks, Digital Services, Managed Services and Other. This reporting structure became effective from fourth-quarter 2017.

Networks revenues were down 14% year over year to SEK 36.2 billion ($4.4 billion). Persistent low investments in mobile broadband in certain markets and lower LTE investments in Mainland China resulted in the poor performance of this segment. Also, earlier completion of larger projects in South East Asia, Oceania & India as well as in the Middle East & Africa hurt the segment’s top line. The company expects China sales to depreciate for the segment, as 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 sales growth in North America, driven by network expansions.

Digital Services revenues fell 9% year over year to SEK 12.9 billion ($1.6 billion). Lower legacy product sales hampered the segmental performance and services performance also displayed weak numbers.

Managed Services sales also declined 7% year over year to SEK 6.2 billion ($745 million).Contract reviews and lower variable sales in certain large Managed Services Networks contracts hindered the segmental performance, and more than offset growth in Managed Services IT business.

Other segment (which includes media solutions, red bee media, iconectiv and emerging business) revenues dipped 18% year over year to SEK 2 billion ($240.4 million), primarily due to persistent lower sales of legacy products in Media Solutions and weak broadcast services sales. This was partly offset by decent performance in Emerging Business, where IoT platforms displayed strong growth.

Ericsson’s adjusted gross margin (excluding restructuring charges) in the quarter expanded 50 basis points year over year to 29.9%. Higher software sales in the Networks unit more than offset reducing margins in the Digital Services business, resulting in the expansion.

However, Ericsson’s adjusted operating margin (excluding restructuring charges) figures were terrible — it went down from 6.7% in the prior-year quarter to 0.7% in the reported quarter. Operating income was affected by higher amortization of development expenses and elevated seasonal costs. Higher R&D expenses and significant impact from capitalization hurt the operating margins.

Restructuring Plan

In March last year, 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 its media business. Ericsson’s CEO had warned last year that an uncertain market could wipe out as much as SEK 5 billion ($600 million) of operating income over 2018. There is also an heightened 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 also 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 its product roadmaps.

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 anticipated roll-out of 5G networks.

For the fourth quarter, restructuring charges came in at SEK 2.4 billion, while provisions and customer project adjustments amounted to SEK 3.2 billion. Also, the write-down of assets had an impact of SEK 14.5 billion on operations.

Restructuring charges for 2017 came in the range of SEK 8.5 billion (lower than the previously expected range of SEK 9-10 billion).

Earlier this month, Ericsson announced another colossal writedown, by booking charges roughly amounting to a whopping $1.8 billion. After an impairment testing, the company decided to write off assets worth SEK 14.2 billion. The writedowns primarily affected two of its businesses — digital services, and the cloud computing and media unit. Another SEK 1 billion ($125 million) non-cash charge was booked due to the recent U.S. tax reform.

Total restructuring charges for 2018 are estimated to lie in the range of SEK 5-7 billion.

Liquidity

During the quarter, cash flow generated from operating activities came in at SEK 11.2 billion ($1,346 million) and SEK 9.6 billion ($1,153.9 million) for the full year. Ericsson’s net cash at year end, came in at SEK 34.7 billion ($4.2 billion), compared with SEK 31.2 billion a year back.

To Conclude

2017 was a challenging year for Ericsson. Commercial risks for the company have reduced meaningfully due to the creation of provisions and adjustments relating to customer projects amounting to SEK 3.2 billion. Ericsson is also cutting its workforce by 10,000, which should save operating costs.

Ericsson projects a 2% drop (earlier projection was an 8% decline) in the market for radio access network equipments this year, which is worse than previously expected. The company sees gradual improvement in Networks, even as Digital Services continues to see significant losses.

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. The Chinese market will likely continue to contract due to declining LTE investments, even as North America enjoys a positive momentum.

Nevertheless, Ericsson still expects to stabilize its operations amid a difficult market in 2018. Ekholm’s restructuring plan will help streamline the company’s focus areas, improve profitability, and revitalize its technology and market leadership. The company also plans to explore options for the 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 impact 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 Corporation NOK and Cisco Systems, Inc. CSCO.

Stocks to Consider

A better-ranked stock in the broader sector is Comtech Telecommunications Corp. CMTL, flaunting a Zacks Rank #1 (Strong Buy). You can see the complete list of today’s Zacks #1 Rank stocks here.

Comtech Telecommunications has a robust earnings surprise history, with an impressive average positive surprise of 88.7%, driven by huge, consecutive earnings beats over the trailing four quarters.

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Note: SEK1 = $0.1202 (Period average from Oct 1, 2017 to Dec 31, 2017)

 

         SEK1 = $0.1217 (as at Dec 31, 2017)

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