Spirent's dividend yield starts to look appealing

When looking at Spirent Communications' (SPT) investment case, it's worth assessing its cyclical exposure. The network testing business performance was closely tied to the telecoms companies’ investment plans and historically they have cut back during economic downturns.

The theory was that telecoms wouldn’t be able to pull back on 5G spending because they had so much catching up to do. But they have cut back on everything else and they are still dragging their feet on 5G. In the six months to June, Spirent’s year-on-year revenue and operating profit dropped 20 per cent and 76 per cent, respectively, after a particularly difficult first quarter. The drop was fairly evenly split across the life cycle assurance and security businesses.

The good news is the order book is at a record $303mn (£239mn) and management said it saw a pick-up in activity in the second quarter. This year is expected to be more heavily weighted towards the second half, with broker Jefferies forecasting full-year revenue to be down by just 3.6 per cent. 

Promisingly, gross margins stayed at 71 per cent. Spirent uses software to test and monitor the networks so its cost of sales is relatively modest. Adjusted operating margins dropped from 17 per cent to 5 per cent because of the drop in sales. However, when the market recovers operational leverage will kick in and it will start to close the gap between gross and operating margins.

Big recent share price drops mean it is now trading at a forward price/earnings ratio of 11. Jefferies points to the fact this is a big discount to competitors Keysights (19) and Viavi (17.5). It has been a tough year for Spirent, but for such a high-margin business the valuation is appealing. Have patience and enjoy the 4 per cent dividend yield. Buy.

Last IC View: Buy, 184p, 7 Mar 2023