EUR 850.00 For Business Accounts Only

Morningstar | Cyclical Weakness May Be Indicative of Structural Headwinds For Juniper; Maintaining $26 FVE

Narrow-moat Juniper Networks saw a disappointing coda to fiscal 2018, with the top line coming in appreciably below our expectations as well as the guidance range, though adjusted earnings were marginally above expectations. The firm continues to struggle within an industry undergoing secular shifts, primarily the disaggregation and shift of the value proposition from the performance-specifications of hardware to agility-enabling software. Strength within the enterprise vertical was offset by weakness in service provider and cloud, as the latter two continue to deploy infrastructure at slower cadences as they transition their network architectures. We will maintain our $26 fair value estimate, and though shares dipped as much as 7% after hours, we do not see an appropriate margin of safety for prospective investors. Our negative trend rating also remains intact, as we believe the challenges that management views as cyclical will prove to be structural longer term.

Revenue of $1.18 billion and $4.65 billion, for the fourth quarter and full year respectively, represented year-over-year declines almost 5% and 8%. For the full year, declines of 16%, 3% and 2.6% in routing, switching and services, respectively, were offset by a commendable 13.5% increase in the security business. Management continues to tout their success in returning this business to growth, citing a more uniform and integrated approach to cross-selling their security portfolio. Still, we continue to view this space as one mostly not conducive to moats, given the intense competition and ease of functionality replication.

Margins compressed for the full year, with adjusted gross and operating margins contracting by 210 and 440 basis points, respectively, to 59.9% and 18.1%. While software (which grew 32% year over year during the quarter) is margin-accretive, we continue to expect flat to slight margin degradation, due to adverse product mix and continued pricing pressure over time.

We continue to find management’s pricing commentary surrounding the cloud vertical quite telling. Though the MX to PTX transition has largely matured, management indicated that they continue to see per-port price degradation within the PTX routing family, which they attribute to the normal declines expected as one progresses through a product lifecycle. Indeed, the modest increase in port volumes have not been enough to offset the pricing declines. Management believes this is more of a timing issue, and that an inflection point is on the horizon where the increased footprint will begin to offset pricing declines. We posit, however, that the slower cadences in port growth are emblematic of a paradigm shift, whereby network hardware is refreshed less frequently and customers rely more on the automation and orchestration capabilities of network software platforms.

As traditional differentiation through "speeds and feeds" becomes less germane, the firm continues to push its software platforms as the glue that can integrate and manage network and security assets deployed across multiple clouds and topologies. We maintain, however, that the firm will be hard-pressed to achieve the same level of competitive differentiation in this realm as it has in the past with hardware. Additionally, we see little upside in the firm’s other businesses. Ethernet switching in the enterprise will continue to be commoditized and disrupted by the secular trend of workloads shifting to the cloud. Management believes they can offset this by achieving further penetration within the WAN of hyperscale cloud providers. From our vantage point though, despite their highly-touted 400 GbE switching portfolio, there is no guarantee that they will be successful in winning footprint inside hyperscale data centers. More importantly, to the extent that the firm does see success here, we do not believe that it will be able to earn economic rents, given the negotiating clout that the hyperscalers wield. The firm’s current routing challenges lend credence to this belief, and ultimately to our negative moat trend rating.