Should We Buy These 2 Telecom Companies?

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

For years now, analysts have called for the gradual demise of landline phone service, as customers understandably save money by switching solely to cellular phones. That argument grew even stronger after massive landline operator CenturyLink (NYSE: CTL) released disappointing earnings earlier this week. The company slashed its juicy dividend by a sizeable 26% and gave an uninspiring earnings forecast , which led to multiple downgrades and a more than 20% drop in the stock. This naturally leads one to ask: Which companies will benefit the most from this shift of landline to wireless usage? In my opinion, the two biggest and most capitalized companies in the industry, Verizon Communications (NYSE: VZ) and AT&T (NYSE: T) are the ones to own.

What makes Verizon so great?
Verizon is simply ubiquitous, with an annual revenue base exceeding $115 billion and market capitalization over $125 billion. This Dow component is much better-positioned than most other telecom companies, such as CenturyLink, Windstream, and most other predominately landline operating phone companies.

Verizon wisely focused on growing its wireless business long ago, and that move has paid off greatly, to the tune of over $13 billion in annual free cash flow. With approximately 100 million wireless subscribers, the company continues to benefit from a strong network and brand name, which could help spur more people to make Verizon as their carrier of choice. Its most earnings report, which showed a healthy 8.5% in service revenues growth and a record high 2.1 million retail postpaid net connections, further proves this point.

With this massive amount of cash flowing in, the company has been able to reward shareholders through massive share buybacks and a consistently growing dividend -- now a tempting 4.6% yield. With the company priced at a relatively cheap 1.1 times sales,  trading for less than six times enterprise value to EBITDA, and sporting strong returns on equity exceeding 12%, I think Verizon will serve long-term investors quite well.

Will AT&T keep answering investors' calls for dividends?

AT&T (NYSE: T) is simply a behemoth, with an annual revenue base exceeding $127 billion and market capitalization over $195 billion. The company undoubtedly benefits from a variety of factors, including a fantastic brand name, massive economies of scale, a huge network, and a diversified revenue base.  AT&T is the only other company, along with Verizon, to have roughly 100 million wireless subscribers as well, while the very distant No. 3 competitor Sprint barely has just over half that number and pays no dividend to boot.

In the meantime, AT&T also spits out a very nice and consistently growing 5.1% dividend. Like Verizon, it habitually buys millions of shares each quarter as well. With annual free cash flow in excess of $14 billion, investors should feel confident that the share buybacks and dividend increases will continue.

The Foolish conclusion:

Telecommunications is clearly here to stay, and will continue to grow. However, one must realize that the landscape is changing as more and more customers are switching from landlines to wireless phones. Only a certain few companies will benefit, while others will see business suffer. My take is that Verizon and AT&T will be those two beneficiaries. Meanwhile, many of the landlines are value traps, with artificially high dividend yields and massive debt loads that will be hard to service.


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