Sierra Wireless, Inc.: The Bear Case From a Bull

Sierra Wireless (NASDAQ: SWIR) stock is hot right now. Shares of the Internet of Things pure play are up nearly 80% so far in 2017, helped by a pair of strong earnings reports in February and May. Sierra Wireless outlined solid growth in each of its segments with those reports, perhaps most importantly including an ongoing rebound for its core OEM solutions business.

But while I'm a firm believer that winners keep on winning and have advocated recently that investors buy shares of Sierra Wireless even after the recent climb, I also know it's important to remain cognizant of its risks. With that in mind, let's take a closer look at the bear case for Sierra Wireless stock right now.

Sierra Wireless has come a long way

Perhaps the most logical argument stems from the fact that Sierra Wireless stock has risen so much, so quickly. As of this writing, shares trade at a lofty 62 times trailing-12-month earnings -- though they also look more reasonable at around 24 times this year's expected earnings, assuming the company is able to sustain its recent momentum.

So what could throw a wrench in that momentum? For one, watch for any hiccups in demand from customers in the aforementioned OEM solutions business, where sales climbed 10% year over year and comprised around 82% of total revenue last quarter.

To be fair, Sierra Wireless benefited from a nicely diversified base of customers and programs last quarter. The company credited OEM growth to improved demand across multiple segments, including automotive, energy, payments, mobile computing, and networking. So it would probably take something like broader economic weakness -- similar to the macro headwinds that held back its growth for much of last year -- to put a chink in Sierra Wireless' OEM armor going forward.

Acquisitive margin headwinds

Next, investors should watch whether Sierra Wireless can improve gross margin, specifically in the promising Enterprise Solutions segment. Last quarter, Enterprise Solutions gross margin fell slightly on a year-over-year basis to 48.3% -- below their stated goal for the segment of at least 50% -- primarily as a result of the contributions from the company's acquisition of in-vehicle cellular device specialist GenX mobile in last year's third quarter.

For now, Sierra Wireless is using GenX mobile's telematics expertise to improve the capabilities of its popular AirLink product line. And in recent quarters it has also invested resources toward the integration of GenX into the broader business in the form of higher production capacity, as well as integrating Sierra Wireless' own embedded modules into its telematics and asset tracking device roadmap.

When asked about their declining enterprise margins during Sierra Wireless' first-quarter 2017 conference call in May, CFO Dave McLennan elaborated, "As we continue integration, we certainly hope to improve those margins, but that is the main driver of the impact."

Impending cloud and connectivity growth?

Finally, revenue from Sierra Wireless' smaller cloud and connectivity services business -- which was included under enterprise solutions until late 2015 -- climbed just 2.1% year over year (up 4.4% at constant currency) last quarter to $7.1 million. This revenue primarily came from recurring services, and Sierra Wireless' primary focus for cloud and connectivity right now is acquiring new customers and expanding its program pipeline to drive growth over the longer term.

During last quarter's call, CEO Jason Cohenour told investors, "[W]e're working very hard to drive the overall mix of the business to favor higher growth in both enterprise and cloud and connectivity."

However, we've yet to see those customers and that pipeline begin to yield fruit in terms of sustained, profitable growth. That's not a problem right now, of course, in these early stages. But if this budding segment fails to gain traction in the coming quarters, I suspect the market's resulting skepticism may not be kind to the price of Sierra Wireless shares.

In the end, I'll admit it's difficult to build a true bear case for Sierra Wireless stock, as the company's recent performance shows it is perfectly positioned to play a central role in the burgeoning Internet of Things industry. But if it suffers any setbacks in the above-mentioned areas, I won't be surprised if the stock pulls back from here.

Find out why Sierra Wireless is one of the 10 best stocks to buy now

Motley Fool co-founders Tom and David Gardner have spent more than a decade beating the market. (In fact, the newsletter they run, Motley Fool Stock Advisor, has tripled the market!*)

Tom and David just revealed their ten top stock picks for investors to buy right now. Sierra Wireless is on the list -- but there are nine others you may be overlooking.

Click here to get access to the full list!

*Stock Advisor returns as of June 5, 2017

Steve Symington has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Sierra Wireless. The Motley Fool has a disclosure policy.