Swedish telecom equipment maker Ericsson reports its second-quarter results on Tuesday, but the market's attention is already shifting to what the company will say about the months ahead. Analysts at Morgan Stanley expect the company's core Networks unit to guide for a modest decline in profitability in the third quarter, reflecting ongoing headwinds in North America and higher input costs.
What Morgan Stanley Expects
In a July 10 European earnings preview, Morgan Stanley said it expects Ericsson to guide for Networks gross margins of 48% to 50% in the third quarter. That would represent a drop of about 100 basis points (one percentage point) from the prior quarter. Gross margin is a key profitability metric that measures the percentage of revenue left after subtracting the direct costs of producing goods.
The bank cited two main pressures: weak demand in North America, one of Ericsson's largest markets, and elevated costs for semiconductors and other components. Telecom operators in the region have been pulling back on spending as they digest previous investments and face an uncertain economic outlook.
Cost Cuts Have Helped, But Demand Remains Soft
Morgan Stanley acknowledged that Ericsson's ongoing cost-cutting and efficiency programs have helped keep Networks performance 'better than feared' in recent quarters. The company has been trimming headcount and streamlining operations to protect margins amid a broader industry downturn.
However, the bank cautioned that the Q3 guidance is likely to mark a pullback from the relative stability seen in the first half of the year. The telecom equipment market has been under pressure globally as operators delay network upgrades and 5G buildouts slow. Ericsson's rivals, including Nokia and Huawei, face similar challenges.
The broader context is that telecom capital expenditure cycles are notoriously lumpy. After a surge in 5G investment in the early 2020s, many carriers are now in a 'digestion' phase, spending less on new gear. This has weighed on Ericsson's revenue and margins for several quarters.
What It Means for Investors
For everyday investors, the key takeaway is that Ericsson's near-term outlook hinges on the pace of recovery in North American demand and the company's ability to manage costs. The Q3 guidance will be a critical signal of whether the worst is over or if more pain lies ahead.
If margins come in at the lower end of Morgan Stanley's expected range, it could suggest that competitive pressures and input cost inflation are still biting. On the other hand, a stronger-than-expected guide could be a sign that the company's restructuring is gaining traction.
Investors should also watch for any commentary on the timing of a rebound in North American carrier spending. Some analysts believe that the current downturn may bottom out in the second half of 2024, but that is far from certain.
Ericsson's stock has been volatile over the past year, reflecting the uncertain demand environment. The company's forward price-to-earnings ratio is modest compared to some tech peers, but that discount partly reflects the cyclical risks.
For context, other companies have faced similar margin pressures from input costs. For instance, Rio Tinto recently faced cost pressures that could force guidance changes, highlighting how rising input costs are a broad theme across industries.
Meanwhile, Helen of Troy lifted its sales outlook but kept profit guidance steady, sparking debate about the balance between revenue growth and margin discipline.
What to Watch on Tuesday
Beyond the Q3 guidance, investors will scrutinize Ericsson's Q2 actual results for any signs of stabilization. Revenue trends in North America and the Networks segment's operating margin will be key metrics. The company may also provide updates on its patent licensing revenue, which has been a source of steady cash flow.
Morgan Stanley's note is just one analyst's view, but it carries weight given the bank's deep coverage of the telecom sector. Morgan Stanley has also flagged cooling orders at Kongsberg despite surging revenue, showing its focus on forward-looking indicators.
Ultimately, Ericsson's next move depends on whether the company can navigate the current trough without sacrificing too much profitability. For now, the market is bracing for a cautious tone.
