3 Telecom Stocks To Not Buy
David is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
As telecom undergoes consolidation, pricing pressure is only likely to increase. This is particularly troubling in light of limited growth opportunities. In my view, Windstream (NASDAQ: WIN), Level 3 Communications (NYSE: LVLT), and CenturyLink (NYSE: CTL) are all expensive stocks that now have more risk than reward. Below, I review the fundamentals of each.
Over the last six months, Windstream has lost 18.9% of its value while the NASDAQ has gained 3.3%. Despite the underperformance, the stock trades at high multiples of 25.1x and 14.4x past and forward earnings - far above the 15.8x historical 5-year average. Much of the current attraction has to do with the firm's 10% dividend yield, but this selling point will be compromised by the -3.3% annual growth forecast over the next 5 years. Based on data from FINVIZ.com, analysts rate the stock around a "hold".
The DSL Internet and wireline provider has been growing inorganic over the past few years. The takeover of CT Communications, Lexcom, D&E Communications, KDL, Norlight, etc. has led to impressive expansion. Windsream provides 3M access lines across roughly half of the states and has impressive scale in fiber-optics. The firm spent $60M on fiber-to-tower investments and now has 1,200 towers with nearly double that planned over the next 12 months.
Inorganic business has benefitted the core business. The acquisition of PAETEC has driven revenue synergies that notably led to the 3.2% y-o-y rise in business service sales. This represents an 80 bps sequential acceleration off of preceding growth. The consumer channel also had impressive y-o-y growth of 5.9%. The main disappointment came in wholesale, which saw revenues decline more-than-expected. Capital expenditures, while guided for a decline to 11%-13%, are still much too high. Free cash flow over the TTM was $685.7M in 1Q12 but north of $700M in 1Q08, 1Q09, and 1Q10. Coupled with the transition to a lower-margin business, I recommend staying on the sidelines to see how the integration works out.
Level 3 Communications
Level 3 is also not for the faint of heart. Over the TTM, EPS was $3.85. The current ratio is below 1 while the debt-to-equity ratio is nearly 7, which indicates high leverage and poor liquidity. ROA, ROE, and ROI are all negative, and the stock is 50% more volatile than the market. Worse yet, the company lacks the primary appeal of communication stocks: a dividend yield! Accordingly, based on data from FINVIZ.com, analysts recommend merely a "hold".
During the second quarter earnings call, management revealed a $0.29 loss, which was 7.4% worse than expected. Core network services business grew only 0.7% sequentially, and, while the firm is on track to meeting 2012 EBITDA guidance, domestic CNS revenue was up only 1.1%. CNS revenue was even worse in EMEA where a 2.3% decline was registered - largely driven by poor performance in the United Kingdom. Management has expressed confident that it will realize the $300M of run rate EBITDA synergies from the accretive Global Crossing takeover. I believe management is on track to beating its guidance with $45M in run rate EBITDA synergies for just this quarter alone.
Free cash flow is still too shaky. Management framed FCF of $3M in 2Q12 as well above -$213M in 1Q12. This is misleading, however. FCF over the TTM in 2Q12 was -$206M versus just -$84M in 2Q11, -$8M in 2Q10, $59M in 2Q09, and -$164M in 2Q08. Coupled with weakening gross margins, FCF declines warrant holding off in Level 3 for now.
In my view, CenturyLink is the most attractive telecom firm of the three. It trades at a respective 43.8x and 17.4x past and forward earnings with a dividend yield of 6.9%. According to FINVIZ.com, analysts rate the stock a 1.9 out of 5 where "1" is a "buy". Analysts also forecast 6% annual EPS growth over the next 5 years.
Assuming that the company meets growth expectations and trades at a multiple of 16x, the future value of the stock will be nearly $46 by 2016. Discounting backwards by 8% yields a present value of $31.31. CenturyLink currently trades at around a 35% premium to my intrinsic value calculation. The dividend distributions basically offset this downside; but, then again, my discount rate was fairly generous at 8%. I believe that, when the economy improves, investors will start flocking into firms with more volatile operating histories. This problem will be exacerbated if the Obama administration is successful in hiking dividend taxes by up to 164%.
First quarter performance was 15.3% above expectations, but the overall record over the past 5 quarters have been spotty with a 9.8% miss in 4Q11 and a 3% miss in 2Q11. On the positive side, FCF over the TTM has taken off with the figure at $2.2B in 1Q12 versus $1.3B in 1Q11 and $670M in 1Q08. I still recommend shareholders hold out for now given how aggressively growth has been factored into the stock.
TakeoverAnalyst has no positions in the stocks mentioned above. 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.