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Morningstar | Juniper Delivers Solid Quarter, but Headwinds Abound; Maintaining $26 FVE

Juniper reported second-quarter results that beat expectations on both the top- and bottom line. Though above guidance, revenue and margins still declined appreciably on a year-over-year basis. The margin compression continues to be spurred by adverse product mix shifts as well as the ongoing MX to PTX transition, with the timing of these cloud routing deployments taking longer than expected. We believe these struggles will be short-lived, however, and management continues to expect a return to year-over-year revenue growth by fourth-quarter 2018. We are maintaining our $26 per share fair value estimate for this narrow-moat name. Shares declined 6% in after-hours trading, but remain fairly valued at current levels. Going forward, management continues to play down the potential impact of white-box and open-source technology on their long-term prospects, viewing the flexibility and programmability of their products as distinct advantages over unbranded alternatives. However, we continue to believe that further commoditization of networking components will become an existential threat to suppliers such as Juniper. Therefore, our negative moat trend rating also remains intact.

Revenue came in at $1.2 billion, representing an 8% year-over-year decrease. This was driven by declines of 14%, 8% and 3% in routing, switching and services, respectively. The security segment provided the one bright spot, increasing 11% year over year, to $79 million. We continue to view security as a no-moat business and believe the firm will struggle to meaningfully increase share in this intensely competitive space.

Adjusted gross and operating margin were 59% and 18.5%, tightening by roughly 3 and 5.5 percentage points, respectively. This can be attributed to the MS to PTX transition issues, as well as to low-margin switching revenue becoming a larger percentage of total sales.

While cloud players and enterprises continue to represent an increasing proportion of Juniper's sales, carriers and service providers in the telecommunications space are still the firm's largest customer base at 43% of revenue. Similar to the commentary of Nokia, one of their competitors, Juniper management alluded to large telcos' cost containment efforts and concession demands as a margin headwind in the quarter as well.

As it relates to their telco customer base, it is important to note that the MX to PTX architecture transition has for the most part been confined to their cloud customers. Management doesn't expect the potential MX to PTX transition in the telco vertical to be a drag on revenue growth similar to what we have seen with the cloud space. However, we view the prospect of this transition as another short- to medium-term headwind, given what has manifested within their cloud vertical and the ongoing trend of networks shifting to more cloud-centric infrastructures. Management has admitted that there are various idiosyncratic factors, which are hard to predict, that have slowed PTX deployment for their cloud customers. Even though the impact on revenue and margins likely would be more muted, we believe similar dynamics would be at play with some of their telco customers in such a transition.