Ericsson Earnings: A Slowdown in North America Network Spending and Poor Margins Weigh on Results

Ericsson ERIC B reported weak sales and poor margins for the first quarter, and management’s outlook for the second quarter pointed to further deterioration in results. Tough comps in 2023 and the firm’s cost-cutting program lead us to believe the firm will return to sales growth and see significantly improved margins in 2024. We’re reducing our fair value estimate by SEK 5 to SEK 95, and we think the stock is materially undervalued despite near-term headwinds.

Weakness in networks, which account for about 70% of total sales and well over 100% of total profits, was expected, but management implied the second quarter will be worse than the first. In the first quarter, organic networks sales were down 2% year over year in constant currency, as strength in India, where carriers are rapidly deploying 5G networks, could not offset challenges in other geographies. A slowdown in 5G network deployments by carriers in North America, by far Ericsson’s biggest geography by sales, and a general working off of inventory after carriers stockpiled equipment when supply chains were disrupted, were the biggest top-line culprits. The mix shift away from North America also weighed on the networks operating margin, which contracted 360 basis points even after excluding restructuring charges.

With extraordinarily high North American spending in 2022, we expect networks revenue to at least stabilize as Ericsson laps last year’s comps. Also, we expect the firm’s sizable cost-cutting program—targeting about 5% of total costs—will lead to networks margin improvement. However, we still see this segment as a cyclical business and, on average, expect little long-term growth in the segment.

Cloud and software services and enterprise results were more encouraging, but both those segments remain unprofitable and have much less impact on total top-line growth. However, the results are encouraging and lead us to believe Ericsson’s business will become less cyclical.