Citi downgrades Spirent Communications as telco demand worsens

Citi downgraded Spirent Comunications in light of worsening demand from the telecoms industry, where capital expenditure is now expected to decline 8% and 10% in the next two calendar years.

After the telecoms and technology testing company's cautious trading update last week, Citi moved the shares to a 'neutral' rating from its previous 'buy' stance and cut its target price to 75p from 90p.

After the profit warning at the interim results, Spirent's otherwise encouraging third quarter report included a wireless revenue decline of 11% due to the "continuing volatility of demand" for its carrier acceptance market - which was "yet another negative surprise", Citi said.

"This highlighted the vulnerability of the business model to current uncertain industry demand as well as ongoing margin pressure," the US bank added, cut its earnings forecasts 2016 and 2017 by roughly 11% but taking much solace from the company's strong balance sheet.

With the tough external environment in the near term, return on investment is a key factor as Spirent puts margins under pressure as it invests in R&D.

Margins have been squeezed significantly from circa 25% in 2012 to neaerer 7.5% in 2015 and are now the lowest amongst its peer group.

The company’s current R&D investment has been running at a higher 26% of sales compared to rivals' 18%, as it attempts to keep pace with changing industry fundamentals.

"We believe that this is the right approach for the long term if the group can rejuvenate its product set and gain market share," Citi said.

"We take the view, however, that in the short-term, investments will continue to run ahead of any associated revenue benefit and question whether the group can generate sufficient ROI in the short-to-medium term."