Mathew Ingram: Sunshine dazzles Nortel view

Sometimes being seen as a financial basket case can have its advantages.

Take Nortel Networks, for example.

The Canadian-based telecommunications equipment maker has been struggling for so long to get its financial house in order - a process that has included a series of earnings restatements and several rounds of layoffs - that even the smallest piece of good news seems like a ray of blinding sunshine.

That's certainly the reaction Nortel got when it reported its second-quarter financial results last week.

After the company boosted its growth outlook for the second half of the year, its shares took off, climbing 12 per cent in a single day on heavy volume, and several analysts upgraded their forecasts for the networking-gear maker, as well as raising their 12-month price targets.

Investors could be forgiven for thinking the clouds have finally parted for the struggling telecom company, but a single quarter's raised expectations doesn't mean that Nortel is in the clover for good.

It still faces some significant challenges in boosting its market share.

Over the past three years, Nortel has taken so many body blows that it's a wonder the company is even standing at all.

It has had to chop billions of dollars from its book value, close plants and lay off tens of thousands of staff, and it faces securities investigations and lawsuits related to its financial performance under chief executives John Roth and Frank Dunn.

The company only recently returned to filing its quarterly statements on time.

Just when investors thought Nortel was finally emerging from its years of turmoil, the company suffered another blow: A few weeks after hiring two senior executives from Cisco Systems to fill out its management team, its new employees suddenly resigned.

Nortel said only that CEO Bill Owen had differed with his new hires when it came to corporate strategy.

Analysts and investors were less than enthusiastic about this sudden change of direction.

Given that kind of backdrop, Nortel's latest quarter definitely came as a breath of fresh air.

Not only did its sales rise by 10 per cent when analysts had expected a rise of 4 per cent, but its profit also increased - although it still came in at an underwhelming US$45 million ($63 million), or 1c a share.

Helping to propel sales higher was the company's business networks division, which saw its revenue rise by 26 per cent over the previous year, thanks in part to Nortel's acquisition of PEC Solutions earlier this year.

Although the improvement came as a pleasant surprise - as did the company's forecast for a 10 per cent rise in sales for the full year - some analysts warned investors not to get too excited about a sudden turnaround in Nortel's fortunes. Although the company managed to maintain its gross profit margins at between 40 per cent and 44 per cent of sales, just as it said it would, several company watchers were sceptical about its ability to continue that kind of performance.

Not only is Nortel competing with companies such as Lucent and networking giant Cisco Systems for sales of corporate routers, fibre-optic gear and wireless equipment, but it is also going up against China's Huawei Technologies - a company whose costs, according to some estimates, are as much as 75 per cent lower than Nortel's.

That is likely to keep continued pressure on the company's profit margins as it tries to match Huawei's prices.

Some analysts were also concerned about the slowdown in orders for wireless equipment, a sector that accounts for almost half of Nortel's revenue.

While the company has a backlog of orders, that backlog has been shrinking, and some industry watchers say they are unsure whether Nortel will be able to ramp up its sales as much as it needs to given the intense competition from Lucent, Ericsson and Alcatel.

A wave of telecom mergers has also intensified competition in the industry, since it has reduced the number of potential customers.

In addition to those concerns, analysts at CIBC World Markets noted that much of the improvement in sales for the quarter came from a one-time software upgrade for Nortel's PBX switches, the kind that are used by many businesses. CIBC also said the quarter's upside "doesn't change NT's murky outlook due to a lack of clear strategy and focus."

At least one other brokerage firm - Moors & Cabot - maintained its "sell" rating on the stock despite the better-than-expected quarter, because it said it was unconvinced about Nortel's ability to boost wireless sales.

Was the latest quarter a ray of sunshine for the networking equipment company?

Definitely.

But does it mean the dark clouds are gone for good? Hardly.