Ericsson warns profit margins at RAN business set to worsen

Ericsson  on Friday reported lower than expected 4th-quarter core earnings as sales of 5G equipment slowed in high-margin markets such as the United States, sending the Swedish company’s shares to their lowest since 2018.

Ericsson is the latest tech company to show the impact of customers tightening belts amid concerns about a global economic slowdown. Others have been cutting staff, including Microsoft  (10,000) and Google parent Alphabet (12,000) which have announced thousands of job cuts this week while Amazon had announce 10,000 layoffs several weeks ago.

Ericsson has already announced plans to cut costs by 9 billion crowns ($880 million) by the end of 2023.

Chief Financial Officer Carl Mellander told Reuters that would involve reducing consultants, real estate and also employee headcount.  “It’s different from geography to geography, some are starting now, and we’ll take it unit by unit, considering the labour laws of different countries,” Mellander said, referring to the cuts.

Mellander declined to say if the job cuts would be similar to 2017 when Ericsson laid off thousands of employees and focused on research to return the company to profitability.

Last week, the company said it would book a 2.3 billion Swedish crown ($220 million) provision for an expected fine from U.S. authorities for breach of a settlement reached in 2019.

Ericsson’s net sales rose in the fourth quarter, but margins, net income and core earnings fell.  Its gross margin for the fourth quarter of 2022 fell to 41.4% from 43.2%.

Ericsson said it expected a fall in margin in its Networks business to persist through the first half of 2023, but the effect of cost savings to emerge in the second quarter.

JPMorgan analysts said given the fall in margins and higher investments, they would expect 2023 earnings to decline by a double digit percentage.

Inge Heydorn, partner and fund manager at investment firm GP Bullhound, said: “The fourth quarter shows once again that the U.S. has a big impact on Ericsson’s margins.”

With U.S. customers such as Verizon tightening their purse strings, Ericsson is hoping newer markets such as India can provide some growth.  Its South East Asia, Oceania and India market was the only one to grow in the quarter, rising 21%, accounting for 13% of the company’s business.

The company’s fourth-quarter adjusted operating earnings, excluding restructuring charges, fell to 9.3 billion Swedish crowns from 12.8 billion a year earlier.  That was short of the 11.22 billion expected by analysts, Refinitiv Eikon data showed.  Net sales rose 21% to 86 billion crowns, beating estimates of 84.2 billion.

A settlement of a patent deal with Apple (AAPL.O) last month resulted in revenue of 6 billion crowns, but Ericsson also took 4 billion crowns in charges, including a provision for a potential fine from U.S. regulators and divestments.

However, there was some good news.

  1. Ericsson said it expects significant patent revenue growth over the coming 18-24 months.
  2. Ericsson, outside China, remains the company to beat in 5G. Its share of the market for radio access networks (RANs) appears to have increased several years in a row – from 33% in 2017 to 39% now.
  3. Ericsson is healthily profitable, which could not be said when CEO Ekholm took charge in 2017.
  4. Boosted by recent takeover activity and a major licensing deal with Apple, its headline sales for the final quarter of 2022 were up 21%, to 86 billion Swedish kronor (US$8.4 billion), compared with the same period a year before.

However, Ericsson has experienced one of its biggest profit slumps since the first half of Ekholm’s tenure. Hurt by higher costs and SEK4 billion ($390 million) worth of one-off charges – relating to US fines, write-downs and divestiture – its net income dropped by 39%, to SEK6.2 billion ($600 billion). Worse, all the various profit margins thinned, with Ericsson’s closely monitored EBIT (earnings before interest and tax) margin shrinking to just 9.1%, from 16.1% a year earlier. And the outlook is frosty.

The mini-boom in 5G spending appears to be over – temporarily, at least. Last year, the market for RAN products, where Ericsson now generates about 70% of its revenues, grew by around 5%, according to data from Dell’Oro, a market research firm that Ericsson uses. This year, RAN market sales are expected to fall by 1%. And in North America, responsible for nearly 30% of Ericsson’s overall revenues, Dell’Oro predicts they will drop by a worrying 7%.

After investing heavily in network rollouts during the last couple of years, many operators are cutting their expenditure amid signs of an economic downturn, and reducing the equipment stockpiles they built up when supplies were tight. “We expect operators to adjust inventory levels as the supply situation eases and we plan for these trends to continue during the first half of 2023,” said Ekholm on Ericsson’s earnings call today.

“The first half is really where we’ll see the sizeable inventory adjustments,” said Ekholm, answering questions asked by analysts. “Operators can sweat assets for a couple of quarters but it cannot be done much more [than that] because of the traffic growth underneath. That is the way to model it.” Ericsson’s expectation is that total mobile data traffic worldwide will grow by a factor of five between 2022 and 2028.

Given the market slowdown, turbulence of the last year and seemingly endless difficulties at smaller units, it is easy to forget that Ericsson remains a solid and successful business. But it has become more reliant on RAN sales under Ekholm – generating more than 70% of its revenues in that market last year, compared with just 47% in 2016. Ekholm clearly restored Ericsson’s reputation as a RAN provider. Amid the slowdown in that sector (zero growth forecast by Dell’Oro through 2027), his big challenge now is to prove it can thrive elsewhere.

Andrew Gardiner, analyst at Citi, said the announcements demonstrated the “significant challenges” the company faced this year. “We view Ericsson’s outlook as one of fundamentals deteriorating in the next quarter or two, as it aims to improve in the second half and beyond,” he added.

References:

https://www.reuters.com/technology/ericsson-quarterly-earnings-miss-expectations-2023-01-20/

https://www.lightreading.com/5g/ericsson-feels-squeeze-as-big-customers-slash-5g-spending/d/d-id/782803?

https://www.ft.com/content/dd5cb329-f5bd-4b78-bde1-ca7510daaa7a

 

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