Is This Stock Still the Best Telecom Opportunity?

Brian is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

For more than a year, no one was more bullish on Sprint Nextel (NYSE: S) than myself. In 2012, I chose Sprint as my “Value of the Year” and then stood by that decision as the stock hovered at $2.3 for the first five months of the year. However, like any good investor, reassessing a position is vital to any sustained success. Therefore, is Sprint still presenting the best value in the telecom space?

What made it great?

When I chose Sprint as my “Value of the Year” it was based on very simple logic. At the time, Sprint had traded from $5.5 to $2.2 with a downtrend in the market.

First, I believed that the market would recover. But secondly, I believed that if Sprint was worth $5.5 in the right market environment without the iPhone, it was worth a whole lot more than $2.2 with the iPhone.

At the time – the end of 2011 – the iPhone was the hottest product in technology and was arguably the separation between Sprint and Verizon (NYSE: VZ) and AT&T (NYSE: T). Sprint did not have the product that all consumers wanted, the iPhone, therefore it could not compete.

Thus, when the company earned rights to the iPhone, and its stock was trading at $2.3, it seemed logical that the company could then become more competitive and could perhaps gain new subscribers along with finally stopping the trend of falling revenue. Turns out, this logic proved true.

What is different?

The problem is that at $6.7, Sprint’s valuation has changed. Apple’s iPhone is no longer growing at 25% year-over-year and is now producing near flat growth in the U.S. Sprint is no longer presenting such clear and obvious value, and its chief problem of operating with too many assets relative to its subscribers still leaves the primary question of whether the company can ever achieve profitability?

<table> <thead> <tr><th> </th><th> <p>Sprint</p> </th><th> <p>AT&T</p> </th><th> <p>Verizon</p> </th></tr> </thead> <tbody> <tr> <td> <p>Price/Sales</p> </td> <td> <p>0.55</p> </td> <td> <p>1.52</p> </td> <td> <p>1.23</p> </td> </tr> <tr> <td> <p>Revenue Growth (last quarter)</p> </td> <td> <p>0.5%</p> </td> <td> <p>(1.5%)</p> </td> <td> <p>4.2%</p> </td> </tr> <tr> <td> <p>Forward P/E Ratio</p> </td> <td> <p>N/A</p> </td> <td> <p>13.22</p> </td> <td> <p>15.52</p> </td> </tr> <tr> <td> <p>Operating Margin</p> </td> <td> <p>(11.8%)</p> </td> <td> <p>10.11%</p> </td> <td> <p>12.79%</p> </td> </tr> </tbody> </table>

Looking at the chart above, you might think that with Sprint trading at just 0.55 times sales that it is cheap. However, compared to its larger peers, Sprint’s growth is not outstanding, and its operating margins remain horrendous.

Therefore, its discounted price/sales ratio is a result of its operating inefficiencies, as the market naturally awards higher premiums to those companies that operate with the most efficiency. At 0.55 times sales, Sprint is now fairly valued relative to fundamentals, not undervalued, and with the iPhone no longer producing robust sales growth, the company does not have a catalyst to create excitement.

Where to invest in telecom?

Naturally, my outlook in this space has changed over the years. From 2009 – 2011 AT&T was my largest holding, but in 2012 Sprint became my preferred choice. Now, after a 200% gain, I consider Sprint the worst investment of these three stocks.

Verizon is attractive because it is producing growth, has an established spectrum, and is the nation’s largest wireless provider. However, Verizon and AT&T operate a near identical business, although according to both sales and operating margins, Verizon does appear to be the cheaper stock.

With this in mind, I like AT&T the best. For one, AT&T pays a dividend of 5% versus Verizon’s 4.1%. Also, AT&T’s margins are lower because it has made the most aggressive investments for future growth, which I like to see in a competitive industry.

Lastly, I really like the move that AT&T is making to acquire Leap Wireless. Not only would Leap add 5 million subscribers, but also a largely unused spectrum with the capability to expand AT&T’s network by 100 million users. Therefore, when looking at two very similar companies, I believe that AT&T has the most short-term catalysts, making it a better investment.

Final Thoughts

In my book Taking Charge With Value Investing (McGraw-Hill, 2013) I guaranteed that a then $2.35 Sprint would exceed $5 by the book’s publication -- I was right -- but more importantly is that I explain how short-term memory can be good in the investment world, as you must get in, get out, and then forget.

Too often, retail investors want to hold on to their strong performers, and then remain loyal to a fault as the outlook changes with a stock’s price. However, the key to success is to understand that as a stock’s price changes, as does its outlook. With this in mind, Sprint did what was expected, and proved the logical investor to be correct. But after such large gains, it now appears time for that logical investor to realize that value has run its course, and better opportunities exist elsewhere.

It's incredible to think just how much of our digital and technological lives are almost entirely shaped and molded by just a handful of companies. Find out "Who Will Win the War Between the 5 Biggest Tech Stocks?" in The Motley Fool's latest free report, which details the knock-down, drag-out battle being waged by the five kings of tech. Click here to keep reading.

Brian Nichols has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

blog comments powered by Disqus