EUR 850.00 For Business Accounts Only

Morningstar | Ericsson's Networks Segment Brings Long-Awaited Growth; Maintain $7.50 FVE

Ericsson's second-quarter results continued to show the effects of major cost-cutting efforts, leading to year-over-year margin expansion accompanied by roughly flat top line growth. Margin improvements led Ericsson to up its 2020 operating margin goal to 10%-12% from 10%. Despite top line sluggishness, Networks saw a turn for the better with the overall segment bringing in sales growth, which has been absent from the segment of late. We will maintain our $7.50 fair value estimate for no-moat Ericsson.

Total revenue came in at SEK 49.8 billion, down 1% year over year. The only segment to see revenue growth, networks, had sales rise by 2% year over year, adjusted for constant currency. The turnaround in networks' sales was carried largely by continued growth in North America due to the market's prep for 5G. Digital services revenue was down 12% year over year, adjusted for constant currency, due to a decline in legacy offerings and a slow start to Ericsson's new products given a delay in a northeast Asia client contract. Managed services sales were down 3% year over year, adjusted for constant currency, due to contract exits.

In terms of profitability, gross margins (excluding restructuring charges) came in at 37%, compared with 31% last year and 36% last quarter. Ericsson continued to prosper from cost-cutting efforts, the ramp of its higher margin Ericsson Radio System and by addressing its nonstrategic contracts in managed services.

Going forward, we expect Ericsson to be on track to meeting its goal of 10% operating margins by 2020. We believe growth in the networks division will continue, especially in North America, as 5G makes its way to the market and Ericsson's increased investment in R&D will make Ericsson's networks offerings more compelling.