Ericsson faces margin squeeze as sales improve

By @ibtimes on

Is Ericsson's glass half full or half empty? The Sweden-based telecom gear maker is at last enjoying the benefits of an upturn in demand, but much of the growth could come from less profitable areas.

Fourth-quarter results due on January 25 from the world's biggest mobile telecoms equipment maker are expected to show core profit jumping to 8.2 billion crowns ($1.2 billion) from 7.5 billion a year ago.

Yet cost cuts and high-margin network upgrade contracts lie behind the improvement. And some of these trends may weaken in coming months.

For the year ahead, a slower market and less favorable business mix cloud the outlook, analysts say.

The question in 2011 is to what extent will growth balance margin erosion? said Odon de Laporte, analyst at brokerage Cheuvreux. We know that modernization deals in Europe and 3G roll-outs in India will affect margins. Hopefully that will be offset by decent top-line growth.

Ericsson slashed costs during the downturn, offsetting falling revenue and pushing its gross margin up to 39 percent in July-September.

It continues to cut costs but contracts to modernize base stations in Europe and 3G roll-out in India are less profitable and will hit margins in the coming quarters.

GOOD VALUE

The poll showed analysts expect Ericsson's gross margin to dip to 37.9 percent in the fourth quarter. For 2011, the gross margin was pegged at 37.8 percent against 38.4 percent for 2010.

Despite such trends, Ericsson shares have risen around 18 percent since the start of last year. The European technology index is up 7 percent.

Ericsson, whose stock was changing hands at 77.7 crowns by 7:15 a.m. EST, trades at around 12.7 times estimated 2011 earnings, against 11.8 for Nokia and 15.5 times for Alcatel-Lucent, according to Thomson Reuters data.

On Wednesday, banking group Nordea raised its target on Ericsson to 84.5 crowns from 83.

If they can deliver growth and protect margins, you can say the valuation is rather attractive, Cheuvreux's De Laporte said. I see more upside risks than downside risks.

Most analysts see the telecoms gear market growing by low single-digit figures this year after shrinking in 2010.

The United States, which has been Ericsson's biggest single market for the last year, should remain strong, India will pick up and there should be some recovery in Europe.

But we shouldn't set too high expectations, said Helena Nordman-Kuntson, analyst at Ohman.

For the full year 2011, group sales are expected to rise 4.5 percent, the poll showed, after a 3 percent fall in 2010.

Analysts said a stronger Swedish crown could dampen reported sales growth, but played down pressure from rivals such as China's Huawei and Nokia Siemens Networks

Ericsson didn't lose market share in 2010, Ohman's Nordman-Knutson said. Why should they in 2011?

(Editing by David Holmes)

($1=6.652 Swedish Crown)

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