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Networking Equipment: New Cycle in Enterprise Upgrades to Finally Lift the Sector

Arista Networks (ANET) reported strong Q4/2021 financial figures with both top and bottom lines topping expectations while also providing bullish FY/2022 guidance. During the most recent quarter, revenues amounted to $825M (consensus $790M) with EPS totaling $0.82 (consensus $0.74). More importantly, management reaffirmed growth expectations of 30% y/y for FY/2022 with operating margins expected to be 38% for 1Q/2022. The key points communicated by management during the conference call included increased enterprise diversification (with international growth increasing 40% y/y) along with continued cloud strength. That said, it was noted that shipments remain constrained and will likely continue throughout FY/2022, with several decommits announced last month as lead times for certain chips are pushing to between 50+ weeks. Management noted however that the company maintains inventory and purchase commitments that in total exceed $3.0B, an amount which equates to several years worth of supplies. Within Core Enterprise, the Campus segment is still in the early innings and is expected to grow once again at 100% y/y.

Networking equipment manufacturers have largely underperformed over the last few years as Cisco (CSCO) added +6.1%, Juniper Networks (JNPR) +11.8%, Ciena (CIEN) +19.4% and Arista Networks (ANET) +25.6% all underperformed the NASDAQ Composite’s return of +27.9% over the last three years.

We tend to believe that a new enterprise upgrade cycle for networking and optical equipment is taking shape post-pandemic. Given the networking sector’s relative underperformance to the broader tech sector over the last few years, we note that the secular shift to enterprise digitalization, the continued scaling of datacenters and the on-going migration to the cloud and metaverse will continue to act as a positive tailwind, more so now (post-pandemic) than ever before. Companies such as Cisco, Juniper Networks, Ciena Corporation and the aforementioned Arista Networks will not only benefit from the $100B+ stimulus funds for broadband rollout in the US, but will also have the added benefit of Huawei and other China based networking equipment vendors banned from most western countries.

For exposure to the sector, we have sold on strength part of our position in Arista Networks post quarterly numbers (despite still being positive on the company’s outlook) in order to initiate a basket approach and add Juniper Networks and Ciena Corporation to our holdings. With Juniper, we note the solid backlog heading into FY/2022, (increasing to nearly $400M at Q4/2021?), the very achievable 7%-9% y/y revenue growth target for FY/2022 (we believe the risk is on the upside) and growing profitability as seen with operating margins approaching 20%. We see similar dynamics with Ciena, along with a significant broadband opportunity with AT&T in the Passive Optical Network market.

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