A Look At 3 Telecom Stocks To Buy
David is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
If the fiscal cliff has you worried about dividend investments, there are still strong reasons to back telecom stocks. The smartphone boom has been spreading rapidly throughout the country and into emerging markets. From Verizon's first-mover advantage in 4G LTE expansion to AT&T's spectrum acquisitions, carriers still have a strong growth curve ahead, so don't assume a bearish outlook based on dividend yields. Below, I review 3 telecom stocks with a more optimistic outlook in mind.
Key Investment Points About Verizon (NYSE: VZ)
As an early-mover in telecom, Verizon has well positioned itself for margin expansion, sustainable business, and a sharp growth curve. Surprisingly, Verizon continues to increase wireless share despite an increasing competitive space. Postpaid net additions have not only been on the rise--they have re-accelerated. Average revenue per user also gained 3.7% y-o-y in 2Q12, as Verizon penetrated the rising smartphone market.
With a leading edge in 4G LTE and penetration in smartphones, the telecom firm has a sustainable stream of free cash flow that it can cross-sell into various categories. I am optimistic about FiOS turning around to expand margins from the video platform scaling. According to Jefferies, there are several catalysts for Verizon: (1) better management of subsidy expenses from lower upgrades, (2) better-than-expected LTE proliferation, and (3) an uptick in non-farm payrolls to drive wireline.
To be sure, the company faces several headwinds. The firm offers a dividend yield of 4.8% and now that President Obama has been re-elected, shares could be hit should the fiscal compromise fail to scale back on an automatic hike to 43.8%. The reason being is that the Obama administration is pushing to hike dividend taxes by 164%, and, in order for stocks to return to their equilibrium after-tax dividend yield, market prices must come down by a commensurate amount. The sovereign debt crisis adds to the downside, as does onerous anti-trust regulation. Even still, I believe the downside factors are relatively muted given that Verizon has lower FX exposure compared to peers and has been aggressive in innovation.
While I am attracted to AT&T's takeover activity, I find that Sprint's recent merger has closed any discount to intrinsic value. AT&T has a strong network and has delivered excellent performance. In the second quarter, it delivered recored wireless profitability but irrationally fell in price off of overblown fears about high cost iPhone sales. Deutsche Bank, for example, had forecasted wireless EBITDA margins to be 42.7%, but it came out 230 bps higher from improved postpaid handset upgrades that lowered subsidy expenses. In the third quarter, EPS of $0.62 came out ahead of expectations by 2 cents despite flat revenue. And average revenue per user ("ARPU") has been on the rise--accelerating to the greatest rate seen in quarters, 2.4%.
With a dividend yield of 5.5% and the largest valuation in telecom, AT&T carries a safe and sustainable economic moat. 6.6% annual EPS growth over the next half decade may not make the stock undervalued, but it is enough to drive meaningful appreciation from growth.
Sprint, on the other hand, carries tremendous risk. SoftBank's decision to acquire a majority stake in the business may have lowered the downside by implicitly giving the company greater breathing room in financing, but investors would be unwise to expect a dramatic turnaround. Sprint is still well behind competitors in 3G and 4G rollouts, and its smartphone position is relatively weak. Aggressive capital expenditures have paid dividends, as evidenced by strong quarterly results and the bull run, but the company is still seemingly eons behind its competitors. And its cheaper data plan offering is unattainable given secular innovation and margin concerns. I thus recommend avoiding and buying stock in more stable peers.
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. Is this post wrong? Click here. Think you can do better? Join us and write your own!