Make Sure You Buy the Right Telecom Stocks
David is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Smartphones have become increasingly popular in the mobile world. This has driven innovation for faster and better quality data plans. Unfortunately, telecom is largely a winner-takes-all-story. Those companies that have expanded into different mediums, or at least have a sizable foothold in one market to leverage into another, are worth backing. Those that have neither are, well, not worth your time.
I find that AT&T and Verizon are both attractive telecom stocks in terms of risk/reward, due to consistent long-term increases in earnings, high dividend yields, and low volatility. Second quarter results were very strong for AT&T, and margin concerns have been overblown. The 5% earnings beat was actually driven by wireless margins that set record levels. In regard to the launch of the new iPhone, I do not believe it will cut too much into this record despite the market response.
While it is true the launch of iPhone 4 in the last quarter of 2011 caused a steep compression in wireless EBITDA margins (a fall of 1,500 bps quarter over quarter), handset upgrades, as Deutsche Bank correctly notes, have trended under run-rates. Stronger upgrade rules have hoped to limit margin erosion.
Verizon has also shown excellent performance, as it not only increases margins but grows market share in wireless. With capital expenditures falling, free cash flow is on the rise to boost the company's access to attractive financing. Going forward, I anticipate expansion into smartphones and FiOS business transitioning into faster cash flow cycles from greater expansion in the video platform. Currently, the company has one of the lowest penetrations in smartphones of the national carriers, which gives it considerable room for upside.
There are also several catalysts that the market has failed to appreciate. Subsidies per handset have been limited by tighter upgrade policies, which keep margins healthy. In addition, the expansion into LTE can be leveraged to win over smartphone users. With Verizon’s stock trading at low multiples, I recommend betting on the future of these catalysts being unlocked.
Sprint (NYSE: S) Not Worth Your Time
Given that the income statement is still in the red and the stock has risen considerably from its low, I do not believe now is the time to jump in with a "buy" order. CDMA postpaid churn has been on the increase,e with a commensurate acceleration in CDMA cell site deployments. By the end of 2012, Credit Suisse anticipates the firm having around 10,000-12,000 cell site deployments.
Even still, return on invested capital is forecasted to be very volatile as net debt rises from $14.7 billion in 2011 to $18.3 by the year's end. iDEN losses and margin pressure further add to the downside story. With poor 4G spectrum compared to AT&T and Verizon, in addition to an unsustainably cheap data plan, the future isn't too bright for Sprint. Accordingly, I recommend holding out on the stock until greater visibility emerges.
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