Why This Double is Still a Value Trap

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

I will admit right away that I have serious misgivings about investors that suggest because a stock has gone up that the company is successful. In fact, I would point those investors to Peter Lynch's comment that in the short-term almost anything can cause a stock price to rise or fall, but over the long term it is a company's earnings growth that determines the direction of the stock. I say this as a preface to the fact that although Sprint (NYSE: S) has doubled since May of this year, this is still a company in my opinion fighting for its very life.

Slow Revenue Growth:
I've written about Sprint in the past, and suggested that the company was headed for zero. This was a bit facetious, as I'm sure someone would propose a buyout before that happened. However, the numbers the company is producing don't point to a positive long-term outlook. In fact, the recently announced merger between T-Mobile and MetroPCS (NYSE: TMUS) would seem to make Sprint's life even more difficult. By several different metrics, Sprint is having difficulty. In fact, over the last four quarters the company's revenue has barely moved. From December of last year, total revenue has only increased by about $100 million. This sounds like a lot, until you consider that this represents just over 1% growth. While it's true that their primary competitors AT&T (NYSE: T) and Verizon (NYSE: VZ) also saw relatively tepid revenue growth, there are multiple other reasons to avoid Sprint going forward.

Earnings? What Earnings?

One statistic that points me away from Sprint as a long-term investment is analysts expectations for earnings, or the lack thereof, over the next year or so. The company is expected to lose money in both 2012 and 2013, with the most optimistic analyst projections still showing a loss next year. With AT&T and Verizon expected to earn between $2.38 and $2.48 respectively, it's not hard to understand why investors would choose to go with the “big two” in the field. Even MetroPCS is expected to report positive earnings both this year and next. Considering that Sprint has more than five times the number of subscribers compared to MetroPCS, it makes you wonder how many subscribers the company needs to turn a profit?

Margins are Getting Worse:

Another factor that makes me wonder about Sprint's current pricing structure is, the fact that the company's gross margins have been compressing since 2009. Between 2009 and 2010, Sprint's gross margin dropped from 49% to 46%. In the last four quarters, the company's gross margin continued to drop. In September of last year, the company's gross margin was 45%, today it stands at just over 43%. By point of comparison, in MetroPCS' most recent quarter, the company's gross margin was almost 50%. An even more difficult comparison is, both AT&T and Verizon reported current gross margins of over 60%. Considering that Sprint is competing directly against these three carriers, this is yet another challenge for the company to overcome.

The Balance Sheet Is Getting Worse Too:

While all of the above problems are challenges to investing in Sprint, there's nothing that gets in my way more than the company's balance sheet. I know some believe that Sprint's debt situation isn't as bad as it has been in the past, but if you look at the long-term trend, the company is getting further and further into debt. Looking back at 2009, the company carried $11.7 billion in net long-term debt. By 2010, Sprint had cut this debt down to $9.7 billion. However, in 2011 the company's long-term debt ballooned to $12.7 billion, and their recent quarter was higher yet again at almost $12.9 billion. Given that each of these figures is a net debt number, this eliminates the argument that Sprint is preserving cash as the overall number is getting worse.

Conclusion:

As you can see, by multiple measures, Sprint is falling behind their competition. The proposed merger of T-Mobile and MetroPCS could threaten Sprint for third place in the wireless industry. In the past, Sprint's lack of iPhone availability was a detriment to the company. However, even though customers can choose the iPhone on Sprint at this time, most customers are still choosing AT&T or Verizon. The fact that both of these competitors have right around 100 million subscribers creates a negative network effect that is hard to overcome. In short, AT&T and Verizon gain subscribers because they already have the majority of the market. Sprint is clearly fighting this battle on price, as shown by the drop in their gross margins. The fact that the company's long-term debt is steadily increasing, is yet another reason to continue to stay away from the stock. Just remember, just because a stock goes up doesn't mean that it's a good investment. This could be a case where as the old saying goes, what goes up must come down.


MHenage owns shares of Verizon Communications. The Motley Fool has no positions in the stocks mentioned above. 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.If you have questions about this post or the Fool’s blog network, click here for information.

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