Ericcson’s Turnaround Is Promising but Doesn’t Bestow It with a Moat

Business Strategy and Outlook

Ericsson is a primary provider of hardware, software, and services to communications service providers. The company is excelling in 5G build-outs and gaining share. 5G may have a longer spending period than previous wireless iterations, and Ericsson’s robust portfolio of hardware and software coupled with its industry-leading services business has it primed to take advantage of 5G network demand. The company has been on a turnaround mission after its 2015 apex. Ericsson is making wise strategic efforts and management’s prudent outlook after slashing its cost of goods sold and operating expenses while committing to exit or renegotiate unfavourable contracts should be applauded. The management team has properly focused the company on invigorating networking innovation while honing operational efficiency.

That said, the CSP equipment provider industry lends itself to economic moats because CSPs multisource vendors and flex pricing power by pitting suppliers against each other. However, Ericsson’s restructuring and strategic efforts, combined with 5G demand, to create top-line growth and operating margin expansion. Ericsson’s efforts within software-defined networking will be fruitful as software becomes essential in a 5G world. Ericsson will gain from 5G networks requiring many small-cell antenna sites to propagate the fastest transmission bands. Ericsson should also profit from 5G networks creating more product use cases such as “Internet of Things” devices in cars and factories. Network complexity will increase as firms control and monitor a rapidly growing quantity of Internet of Things devices, Ericsson’s software and services will be in high demand. The company also creates revenue from licensing patents that are essential in the production of 5G smartphones (as well as previous generations). Ericsson may find licensing opportunities in non-handset markets, and that licensing revenue will help bolster operating results.

Financial Strength

Ericsson is a financially stable company after making drastic changes that put itself into a position to prosper after a tumultuous period that coincided with 4G infrastructure spending declines. It is expected that Ericsson is to generate steady free cash flow and be judicious with its cash deployments. Ericsson finished 2021 with SEK 67 billion of cash and equivalents with a debt to capital ratio of 23%. Ericsson will repay its outstanding debts of SEK 32 billion, as of the end of 2021, on schedule. Ericsson is to focus its expenditures on R&D innovations while continuing to lower its SG&A and product costs. As a percentage of revenue, it is believed that R&D will remain in the midteens and SG&A in the low double digits. Ericsson has paid a steady dividend, although it dipped through its restructuring period, and the company is to gradually increase its payout as operating margin improves. The company does not have any stock repurchase plans

Bulls Say’s

Ericsson’s turnaround measures are happening at an opportune time. Management’s focused strategy could expand operating margins while 5G infrastructure spending increases top-line results.

5G may afford Ericsson a longer spending cycle and higher equipment demand than previous wireless generations. Additionally, 5G should create more use cases for Ericsson’s software and services within Internet of Things device networks.

Income sources could diversify as licensing revenue from 5G patents may grow through applications outside of Ericsson’s handset manufacturer agreements.

Company Profile

Ericsson is primary supplier of telecommunications equipment. The company’s three major operating segments are networks, digital services, and managed services. Ericsson sells hardware, software, and services primarily to communications service providers while licensing patents to handset manufacturers. The Stockholm-based company derives sales worldwide and had 101,000 employees as of June.

(Source: MorningStar)

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