Four telecom stocks for dividend and diversification play

Leading carriers on both sides of the U.S.-Canada border have reported solid revenue, earnings, and free cash flow growth in their most recent quarterly reports

Vikram Barhat 19 December, 2018 | 6:00PM

As markets continue to seesaw between hope and despair over the outcome of the US-China trade talks, major indexes appear set to end the year in the red. The best way for investors to deal with this seemingly unending market rodeo is to not pay any attention at all. Instead, they should explore longer-term growth stories that aren’t beholden to short-term macroeconomic headlines.

A good start could be to look at sectors that comprise companies whose offerings are an indispensable part of human existence. One of them is the telecommunications sector. Telecom companies provide essential services -- wireless, internet and cable – which people need in this digital age no matter where the stock market or the economy are.

Leading carriers on both sides of the U.S.-Canada border have reported solid revenue, earnings, and free cash flow growth in their most recent quarterly reports. Yet, their share prices and the overall sector performance appear to be telling a different story. For the year to date, the Dow Jones U.S. Select Telecommunications Index and the S&P Telecom Select Industry Index have seen total returns in U.S. Dollar terms of -4.5% and -2% respectively, while the S&P/TSX Capped Telecommunication Services Index has fallen close to 0.2% for the same period, as of December 16, 2018..

As a result, blue-chip Canadian and U.S. telecom stocks are trading either at a meaningful discount or close to their fair value. Investors may want to keep them on their radar screen as a corrective swoon could make them even more attractive as investment bets. These telecom heavyweights have robust business models, competitive and technological advantages, ability to absorb regulatory pressures, and they offer juicy dividend payouts, according to Morningstar equity research.

Verizon Communications Inc
Ticker: VZ
Current yield: 4.10%
Forward P/E: 12.33
Price: US$57.56
Fair value: US$58
Value: Fairly Valued
Data as of Dec. 12, 2018

The largest U.S. wireless carrier, Verizon Communications Inc. (VZ) serves about 88 million postpaid and 5 million prepaid phone customers. The firm generates 70% of revenue through wireless business, while its online media and advertising firm Oath make up the rest.

“We like Verizon’s telecom focus, which should maximize its strengths in the areas it can control while limiting exposure to the rapid changes across the media landscape,” says a Morningstar equity report, referring to Verizon’s efforts to improve network quality, which “has protected its core competitive advantages while maintaining solid returns on capital.”

The firm has built its marketing reputation around these networks and amassed a loyal customer base. In the wireless business, the firm holds roughly 40% of the postpaid phone market, about a third greater than rival AT&T. “Leading scale enables Verizon to generate the highest margins and returns on capital in the industry,” says Morningstar sector director, Michael Hodel, who recently raised the stock’s fair value from US$52 to US$58.

Hodel projects wireless revenues to grow an average of 3% annually over the next five years and forecasts the firm will continue to outperform its rivals in the wireless industry.

AT&T Inc
Ticker: T
Current yield: 6.73%
Forward P/E: 8.39
Price: US$30.14
Fair value: US$37
Value: 20% Discount
Data as of Dec. 12, 2018

The second-largest U.S. wireless carrier, AT&T (T) serves more than 100 million consumers through postpaid and postpaid phone services. The firm generates 40% revenue from wireless services, 25% from consumer and entertainment segment (which includes fixed-line and DirecTV satellite television), while another 18% comes from media assets (HBO, the Turner cable networks, and the Warner Brothers studios).

Following the Time Warner acquisition, AT&T truly became a behemoth. However, “the wireless business remains AT&T’s most important segment, accounting for nearly 40% of total invested capital and about half of EBITDA,” says a Morningstar equity report.

Return on investment has softened over the past five years due to sizeable investments in wireless spectrum, but remains ahead of AT&T’s cost of capital. “Cost advantages versus smaller rivals and the efficient scale attributes of the wireless market should enable the firm to maintain attractive returns,” says Hodel, who projects wireless revenue to grow 5% annually through 2022. The consumer and entertainment segment is also growing steadily, but fierce competition from YouTube and Hulu could limit profitability, cautions Hodel, who pegs the stock’s fair value at US$37.

Ticker: BCE
Current yield: 5.34%
Forward P/E: 15.58
Price: $56.64
Fair value: $62
Value: 9% Discount
Data as of Dec. 12, 2018

One of the biggest telecom companies in Canada, BCE Inc. (BCE) controls nearly 30% of the wireless market through 9 million customers. The company generates 55% revenue through wireline, and 33% from the wireless segment, while the rest is provided by its media business (television, radio, and digital media assets).

“BCE, with its Bell brand, is the most favorably positioned of the four biggest Canadian providers of wireline and wireless services, as we like its competitive edge in both,” says a Morningstar equity report.

BCE is also the biggest Canadian broadband internet service provider, with just under 4 million residential subscribers and a network that passes though three-quarters of the population.

BCE is pushing to boost its cost advantage, a source of its competitive strength, by replacing older copper network with optical fiber over much of its footprint. This will help crimp operating costs, and “allow it to offer speeds comparable to or better than competitors, and charge higher prices,” says Morningstar equity analyst, Matthew Dolgin, noting that the superior network upgrade will improve penetration rate and market share.

At the end of 2017, Bell’s fiber-to-the-home (FTTH) footprint consisted of 3.7 million homes in Ontario and Quebec. The program, which is regarded as 40% completed, is expected to connect 650,000 to 750,000 homes with fiber each year over the next eight to 10 years, says Dolgin, who appraises the stock’s worth to be $62.

“Of the three major Canadian wireless providers, we think BCE is best positioned and will add the most new customers over the next five years,” asserts Dolgin, who projects a 3.5% annual growth rate for revenue through 2022.

Telus Inc
Ticker: T
Current yield: 4.66%
Forward P/E: 15.24
Price: $46.87
Fair value: $49
Value: 4% Discount
Data as of Dec. 12, 2018

One of the big three wireless providers in Canada, Telus (T) controls 30% of the total market with 9 million subscribers. The firm has a dominant presence in British Columbia and Alberta, where it provides internet, television, and landline phone services.

“In recent years Telus has moved to bring fiber to the home over most of its wireline footprint as it upgrades its legacy copper network, leaving it able to compete on more equal footing with cable providers,” says a Morningstar report. Telus is expected to have built FTTH to two thirds of the residences it passes by the end of 2019, the report notes.

“The network improvement cannot be overstated,” says Dolgin, noting that not only will it offer faster speeds than regional rival Shaw, but also “the new network should reduce maintenance costs and allow for higher pricing, all contributing to margin expansion and [leading to] an increasing share of subscribers in western Canada.”

However, wireless is the more profitable of the two segments. Telus enjoys a position of strength in the wireless business which comprises half of total sales. “We expect Telus' wireless business to benefit from industry growth,” says Dolgin, who recently upped the stock’s fair value from $47 to $49, prompted by bigger gains at a faster pace from its FTTH buildout.

Dolgin forecasts continued expansion in Canadian wireless given that Canada currently has less than 90% mobile penetration as opposed to more than 100% in the U.S. and up to 140% in parts of Europe. The trend, he adds, could help accelerate subscriber gains for Telus.

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Vikram Barhat

Vikram Barhat  Vikram Barhat is a freelance writer.