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LM Ericsson (ERIC), the Swedish 5G telecom equipment manufacturer, is finally delivering strong free cash flow. As a result, ERIC stock, given its low valuation and net cash position, looks very cheap here.
ERIC stock, an American Depository Receipt (ADR) representing 1 “B” ordinary share, trades for $6.74 on NASDAQ. The company's market cap is $22.6 billion. Today, Ericsson released its results for the quarter ending June 30.
As a result, it looks like ERIC stock could be undervalued by at least one-third. That puts its value at $9.00 per share, or +34%. This article will explain how this works out.
Strong Free Cash Flow
Sales of its 5G equipment fell 7% Y/Y, but the company is finally showing strong growth in the U.S. market This is after its sales have declined in its international division and especially from lower Chinese sales.
Moreover, Ericsson generated 7.6 billion Swedish kronor (SEK) in free cash flow (FCF), about $722 million (given the exchange rate of USD 0.95/SEK). That represented an FCF margin of 12.7% on its quarterly sales of 59.8 billion SEK ($5.681 billion).
This was partly due to a one-time cash inflow, but its Q1 and Q2 free cash flow still showed a 10% FCF margin. Moreover, the company now has a cash balance of 13 billion SEK ($1.245 billion).
That means that any future FCF that Ericsson generates will add to its net cash position. As a result, this implies a higher valuation for ERIC stock.
FCF Forecasts Imply Higher Valuation
For example, analysts now project $23.77 billion in sales this year and $24.75 billion next year. Therefore, on average its next 12 months (NTM) revenue will be on a run rate of $24.26 billion.
As a result, if Ericsson keeps generating 10% FCF margins, its free cash flow could hit $2.426 billion over the next 12 months. That would raise its net cash balance to $3.671 billion, or 16.2% of its $22.6 billion market cap.
Moreover, using an 8% FCF yield metric, implies that ERIC stock could be worth $30.3 billion in the next 12 months. That can be seen by dividing its $2.426 billion in NTM FCF by 8% (the same as multiplying it by 12.5x). That is 34.1% higher than its existing $22.6 billion market cap.
In other words, ERIC stock could be worth 34.1% more than its price today of $6.74, or $9.04 per share. Moreover, 16% of its present market cap (including NTM FCF forecasts) or $1.08 could be cash per share.
The bottom line is that ERIC stock looks very undervalued here, based on its strong FCF margins. This stock is generally overlooked and this represents a unique play for interested value investors.
On the date of publication, Mark R. Hake, CFA did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
