Why Should You Stay Away From Sierra Wireless (TSX:SW)?

Challenges never end for the Internet of Things (IoT) connectivity chipmaker Sierra Wireless (TSX:SW)(NASDAQ:SWIR). In September 2018, the U.S.-China trade war triggered a cyclical downturn on the demand side of the chip market. The downturn significantly impacted Sierra. Its revenue fell throughout 2019, pushing it into losses. Its stock has declined 65% since mid-September 2018.

The chip industry had just started returning to growth earlier this year. But the COVID-19 outbreak has put the economy in a recession and has clouded the chip industry’s outlook. Sierra stock fell to an eight-year low of $6.25 in March. Even before the COVID-19 pandemic, the company was expecting its 2020 revenue to decline as much as 3%. Its outlook will worsen as the pandemic-driven lockdown disrupts its supply chain and delays the deployment of 5G.

Sierra was struggling even before the COVID-19 pandemic

The increasing number of IoT devices did not bring windfall gains for Sierra. Its IoT modules are just fragments of a larger ecosystem of edge computing. Chip giants like Intel and NXP Semiconductors offer a complete embedded package of sensors, memory, connectivity, processors, and logic chips to help IoT device makers accelerate their go-to market strategy. To develop its niche in the highly competitive IoT market, Sierra started transitioning from low-margin hardware to high-margin device-to-cloud subscription services for IoT devices.

Over the last three years, Sierra has more than doubled its services revenue from $45 million in 2017 to $99 million in 2019. It aims to increase its services revenue to $200 million by mid-2022 and $400 million by mid-2024.

While Sierra’s service revenue is rising steadily, its product revenue is falling at a faster rate because of the cyclical downturn. As it still depends heavily on hardware sales, its overall revenue fell 10% YoY (year over year) in 2019. This decline continued in the first quarter, and its revenue fell 9.3% YoY to US$157.6 million.

The COVID-19 pandemic has disrupted chip supply and demand

Like all technology companies, Sierra has manufacturing and supply chain partners in China, where the COVID-19 outbreak was first reported. The factories in China were shut down due to the pandemic-driven lockdown. Even though manufacturing has resumed in China, Sierra’s suppliers in Malaysia, the Philippines, and Mexico continue to face a lockdown. The global lockdowns have also strained logistics, thereby affecting imports and exports. These supply issues are delaying Sierra’s production schedules and constraining demand for its hardware products.

On the bright side, the COVID-19 pandemic is changing the way companies work. The emergence of social distancing is encouraging industrial and enterprise customers to adopt fully integrated IoT solutions. In the first quarter, Sierra secured five design wins for its IoT solutions, which will generate around US$11 million in recurring service revenue and US$9 million in hardware revenue.

Sierra’s losses might widen in the short term

As Sierra still earns more than 80% of its revenue from hardware, the challenges surpass the opportunities. In the first quarter, the company reported its biggest loss in more than 10 years. Its non-GAAP gross margin fell to 27.7%, and its net loss widened to US$14.7 million. The loss could widen further, as the supply and demand constrains continue in the second quarter. The company is looking to minimize its losses by reducing costs. It has US$72.8 million in cash reserve and US$50 million in revolving credit, with which it can fund its operations for at least six months.

Sierra’s long-term growth prospects remain strong

Sierra has strong long-term growth prospects, as the deployment of 5G and advancements in IoT applications will drive IoT adoption. However, its present is clouded. The stock is trading at just 0.6 times its sales. It might see more dips than troughs until there is some clarity around the rebound. It would be wise to stay away from this cyclical stock in these uncertain times.

The post Why Should You Stay Away From Sierra Wireless (TSX:SW)? appeared first on The Motley Fool Canada.

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David Gardner owns shares of Sierra Wireless. The Motley Fool owns shares of and recommends Sierra Wireless. Fool contributor Puja Tayal has no position in the companies mentioned.

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