En Fuego!

Telecom equipment stocks rocketed upwards on Friday as earnings from Juniper Networks Inc. (Nasdaq: JNPR) confirmed that telecom companies are making new investments in network upgrades.

Juniper, which last night blew past analyst revenue and profit estimates, rose $5.36 (23%) to $28.19 in morning trading (see Juniper Confidently Carries Q4). Other companies in the IP router space, such as Cisco Systems Inc. (Nasdaq: CSCO) and Avici Systems Inc. (Nasdaq: AVCI; Frankfurt: BVC7), followed suit. Cisco was up $1.03 to (3.8%) to $28.19; and Avici rose $2.32 (13.3%) to $19.73.

The Light Reading Index of important telecom equipment and components suppliers was up $8.06 (3.74%) to $223.43. The Index started the year at $188.86 and is already up 18 percent in 2004.

Several factors driving the buying interest include:

• The broader markets have been going up and investors have been in a buying mood
  
  
• Major carriers have recently announced plans to buy new equipment, especially for packet-based networks. And investors have been catching up to the packet convergence theme, outlined here by Geoff Bennett, chief technologist at Light Reading's independent research group, Heavy Reading, last September (see Incumbents Converge on Convergence).
  
  
• Many shares in the telecom market have been the target of short-sellers, who borrow stock and sell it in the hopes that the price will go down. When short-sellers get caught in a rising market, they are often forced to buy shares to cover the ones they have sold short, further fueling the rise.
  
  
• Investors have been speculating that the cycle in the telecom market has bottomed and carrier financial health will improve. Indeed, as spotted in December by Light Reading Insider, there's plenty of evidence that the capital spending cycle has bottomed (see Carrier Capex Set for 2004 Rebound and Packets Key to Capex Comeback). But the question of how much new spending carriers will do hangs on their ability to generate new revenue from services.

This sounds all good. But despite the animal spirits and optimism in the sector, some investment professionals are wary that the stocks are once again being bid up beyond reasonable valuations.

“They could probably go a lot higher but I would not be buying them here,” says Erik Weir, president and CEO of Weir Capital Management. “I think a lot of the reason they are going up is because people were short-selling them."

Weir points out that Juniper is valued at roughly 111 times this year’s earnings estimates.

"The problem is that it's rational and warranted in a small number of cases, but it's not rational and warranted across the board," said Steve Kamman, analyst with CIBC World Markets. "The concern this year is we're still looking at single-digit capex growth and single-digit enterprise IT growth, so it's going to be tough to make double-digit growth across the board."

In a report issued this morning, Kamman raised Juniper's 2004 revenue estimate to $903 million from $800 million and his 2004 EPS forecast to $0.33 from $0.24. For the rest of the year, he says it's likely that investment success will be based on a narrower group of winners capturing the capex dollars in new equipment upgrades.

"The difference between the bubble years and the recovery is they're now spending in a very focused manner, and you're either on board the right train or you're not," says Kamman.

The game will be won or lost based on whether 2004 earnings beat expectations. Earnings estimates in the group may have room for further upgrades from analysts who have fallen behind.

Prior to the earnings call, analyst consensus profit estimates for Juniper were $0.24 cents per share in 2004, according to Thomson Financial/Lancer Analytics. Today, following rising forecasts, analysts now see $0.26 cents in 2004, says Thomson.

But Weir thinks that’s a risky gamble.

”You either made it at the bottom or you didn’t” says Weir. “But it's no surprise to see some of them take estimates higher.”

— R. Scott Raynovich, US Editor, Light Reading