1 AI Stock Being Overlooked By The Market

Networking is a segment that has been largely overlooked in the wake of AI’s unprecedented rise. However, the communication equipment side has exposure to AI because data needs to be stored somewhere.

The most prominent name in the segment is Extreme Networks, Inc. (NASDAQ:EXTR) and to say its share price has been rough sledding is an understatement.

On April 12, the stock hit a fresh 52-week low of $10.58 so is AI’s untapped potential in networking being overlooked?

Why Did Extreme Networks Stock Go Down?

Extreme Networks records most of its top line from the sale of networking equipment. Product sales accounted for 71% of its net revenue in fiscal 2023.

But EXTR share price has been punished, down 34.2% year-to-date, because of poor fundamentals. In the last reported quarter, product sales declined by 16.5% from the prior year’s period.

They still made up 63% of the company’s overall top line, so it wasn’t a surprise to see net revenue decline by 6.9% to $296.38 million.

Management was expecting a subdued Q2 and updated the previous top line outlook just a few weeks earlier from a range of $312-$327 million to $294-$297 million, citing elongated sales cycles. The leadership team stated that more than one of its deals were pushed back at the end of Q2.

Is Extreme Networks Profitable Now?

In spite of the disappointing top line, Extreme Networks is profitable as of the latest quarterly report.

However, there’s more to the story than meets the eye at first glance. Annual net income on a non-GAAP basis grew by more than five-fold between fiscal 2020 and 2021, reflecting unprecedented business momentum. This slowed to a growth rate of 43.2% in FY2022 and then to 41.4% in FY 2023.

Unfortunately for shareholders, this strong annual growth on the bottom line has done a U-turn. In Q2 2024, net income declined by 13.7% from the prior year’s quarter and 32.4% from the previous quarter to stand at $31.48 million.

There are two factors in play causing headwinds. The first is that deals are getting pushed to subsequent quarters, and the second one relates to persistent supply chain issues. That second challenge is surprising because most other companies have resolved similar challenges long ago.

For the same quarter, Extreme Networks’ non-GAAP gross margin expanded from 58.5% in Q2 2023 to 62.5%, while non-GAAP operating income margin fell a bit from 14.9% to 14.8%.

What is Management Saying?

Competition in the communication equipment market segment includes some big names like Cisco Systems, Inc. (NASDAQ:CSCO) and Hewlett Packard Enterprise Company (NYSE:HPE).

Given their size, they are moving fast to strike deals. For instance, Cisco recently acquired Splunk for $28 billion, and Hewlett Packard has a $14 billion pending purchase of another one of Extreme’s rivals, Juniper Networks, Inc. (NYSE:JNPR).

In an interview with CRN, management stated clearly that the company is not looking at equivalent big-budget acquisitions at the moment. Chief Product and Technology Officer Nabil Bukhari commented that such rapid M&A activity indicates a “lot of confusion” as well.

President and CEO Ed Meyercord believes that the company is moving fast in the AI field. Recently, It launched Extreme Labs, for example, and is expecting to harness its AI capabilities.

For the fiscal third quarter, management expects total net revenue to lie in the range of $200-$210 million, implying a decline from Q2. Furthermore, the company is expected to post a loss for the quarter. The forecast is for a non-GAAP loss per share range of $0.17-$0.22.

Will Extreme Networks Stock Go Up?

Extreme Networks stock is likely to go up by as much as 30.7% to $14.58 per share according to analysts consensus.

With that said, sentiment has been softening with 6 analysts revising their estimates downward for the upcoming quarter. Sales are forecast to move lower over the coming year and that will surely hurt the bottom line. Still, on a multiples basis, the stock is trading at only 1.11x its forward non-GAAP earnings growth, which is quite cheap by industry standards.

Clearly, the dimming sentiment has translated into the stock not finding much favor with investors but there is a scope to realize future gains. After all, management expects to deliver targeted AI-laden capabilities to customers, and that could prove transformative.

If there were bright spots to focus on, two big ones are the shareholder yield and the commitment by management to buy back shares. The shareholder yield is 10.3%, which is an impressive figure given the slowing of the top line. And share repurchases signal that, even if the broader market has punished the stock, the top brass think there is solid upside potential from current levels.

It remains to be seen whether they will be proven right because some profitability multiples in particular look very elevated, such as the EBIT and EBITDA figures. So too is the forecasted drop in net income concerning. Nonetheless with $1.22 billion in sales and $1.4 billion in market cap, it’s hard to argue that the stock is particularly expensive on that key metric.

Lastly, a discounted cash flow forecast also reveals upside potential, though less so than analysts believe. A DCF signals upside of 5.4% to fair value of $11.50 per share.

---

The author has no position in any of the stocks mentioned. Financhill has a disclosure policy. This post may contain affiliate links or links from our sponsors.