Competition from cable and wireless outfits continues to plague wireline telecom service providers, which have had to slash prices of their offerings. The stocks in this group have declined 5.1% in the year ending July 31, vs. a 2.6% gain in the S&P 1500 Index, says Todd Rosenbluth, who follows telecommunications stocks for Standard & Poor's Equity Research Services.
Although Rosenbluth has a negative outlook overall for the traditional telecom carriers, he still thinks some stocks are worth buying. CenturyTel (CTL ) is his only strong buy recommendation in U.S.-based telecom services.
Rosenbluth is particularly optimistic about a few companies that supply equipment for billing and customer care for the telecoms, such as Alvarion (ALVR ), a play on the development of WiMax, and Dycom Industries (DY ), which he expects to benefit from Verizon's (VZ ) commitment to deploy its fiber-based initiatives. Billing and customer-care providers that he favors include Amdocs (DOX ) and CSG Systems (CSGS ).
Among the larger companies in the sector, S&P likes Motorola (MOT ) and Cisco Systems (CSCO ), Rosenbluth says.
These were a few points Rosenbluth made in an investing chat, presented on Aug. 2 by BusinessWeek Online on America Online, in response to questions from the audience and from BW Online's Karyn McCormack. Edited excerpts follow. AOL subscribers can find a full transcript at aol.businessweek.com/chat.
Note: Todd Rosenbluth is an S&P Equity Research analyst. He has no ownership interest in or affiliation with any of the companies under discussion in this chat. All of the views expressed in this chat accurately reflect the analyst's personal views regarding any and all of the subject securities or issuers. No part of the analyst's compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed in this chat. For required disclosure information and price charts for all S&P STARS-ranked companies, go to spsecurities.com and click on "Investment Research" and then on "Required Disclosures & Standard & Poor's STARS vs. Closing Prices Charts."
Q: How have telecom stocks performed lately?
A:For the telecom services [wireline] subindustry that I follow, we remain negative. The stocks in this subindustry have declined 5.1% in the year-to-date period ended July 31, vs. a 2.6% gain in the S&P 1500 Index. In the last three months, the subindustry has also trailed the broader market, rising 3.9%, vs. the 7.7% gain in the 1500.
Q: Why have they been down this year?
A:Well, we believe these telecom stocks reflect the competitive pressure from cable and from wireless competition that has lead to a reduction in local phone lines and forced the telecom carriers to respond with aggressive pricing initiatives. Although we expect this trend to continue, we believe there are some stocks worth buying in this group, which I'm sure we'll get to, as well as some sell recommendations in this telecom subindustry.
Q: What's your outlook on the regional Bells, and do you think they will be viable competitors with cable companies?
A:We cover all four of the regional Bell stocks at Standard & Poor's. We have a buy recommendation on the shares of Verizon Communications (VZ ), a hold recommendation on the shares of SBC Communications (SBC ), and sell recommendations on the shares of Qwest Communications (Q ) and BellSouth (BLS ).
We believe that Verizon has the strongest fundamentals, due in part to the strength of its wireless unit and its ability to keep its EBITDA [earnings before interest, taxes, depreciation, and amortization] margins relatively stable and above its peers despite the cable competition you referred to. We believe the cable carriers will provide sizable competition in most of the markets the regional Bells operate in.
Q: Where do you see Verizon in the near future -- say, three years? What's your view of Verizon's broadband strategy to enter the video/TV market?
A:We believe the company is gearing up for an intense fight with cable carriers, and that its fiber-based broadband initiative has some unique features related to a video high-speed data integration.
However, we believe, given the early stage of development, there are still challenges ahead for the company. We have a 12-month target price of $42 and believe the pending acquisition of MCI (MCIP ) will help the company to compete nationwide in both the consumer and enterprise markets.
Q: Do you see any more consolidation for the telecom-services group?
A:Well, we believe it has been a busy period for M&A activity, given Verizon's pending deal for MCI and SBC Communication's pending deal with AT&T (T ), as well as previously mentioned wireless deals. However, we expect that the approval process for these two large wireline deals will result in the selling of overlapping assets, including local phone lines.
We think smaller telecom companies, such as CenturyTel (CTL ), will be interested in increasing their customer count over the next 12 months. CenturyTel is the only strong buy recommendation within our U.S. telecom services coverage.
Q: Where will WiMax technology take this sector?
A:We believe that WiMax is a focal point in the telecom services industry and have positive recommendations on the shares of both Alvarion (ALVR ) and Airspan Networks (AIRN ).
We believe these companies will benefit from ties to select wireless suppliers as partners and the overall commercial rollout of WiMax. As for Alvarion, we expect fixed WiMax equipment sales to begin to accelerate with the incorporation of a lower-cost Intel Premise chip, expected in the third quarter.
Q: What are your top plays for the balance of this year and 2006?
A:In telecom services, CenturyTel is our only U.S. 5-STAR, or strong buy, recommendation. However, broadening the universe to include companies that supply equipment or billing and customer care for the telecom space, we have strong buy recommendations on the aforementioned Alvarion, a play on the development of WiMax; Dycom Industries (DY ), which is rated as a strong buy due to our view of Verizon's commitment to deploy its fiber-based initiatives; Amdocs (DOX ), which provides billing and customer care for telecom customers and is ranked as a buy; and CSG Systems (CSGS ), which provides billing and customer care for the cable companies that are rolling out telephony offerings and is ranked as a buy by S&P.
Other buy recommendations in this broad space include Motorola (MOT ) and Cisco Systems (CSCO ), which is ranked as a strong buy.
Q: Do those companies you just mentioned pay dividends? In the past, that's what attracted investors to telecom stocks. Is this still the case?
A:Many of the names that I mentioned are telecom-equipment stocks, and thus a dividend payout isn't where they put their free cash flow.
However, in telecom services, the payment of a dividend is a sign, in our view, of the stability of its cash flow. Among the dividend-paying telecom stocks we favor are Verizon, CenturyTel, and another rural telecom company, Citizens Communications (CZN ), whose dividend yield is above 7%.
Q: Now that you have mentioned the strong buys and buys, how about the sells?
A:We have sell recommendations on BellSouth, which is trading above our 12-month target price of $25; a sell recommendation on Qwest Communications, which reported results today (we have a $3 target price on Qwest); and we have a sell recommendation on Alltel (AT ), with a $60 target price. We believe the recently completed purchase by Alltel of Western Wireless will create challenges for Alltel.
Q: What's your take on Nokia (NOK )?
A:We have a hold recommendation on the ADRs [American depositary receipts] of Nokia. We think the company's succession plan for its president and CEO is positive from a corporate governance and shareholder viewpoint. While we see long-term competitive challenges for Nokia, with the shares priced below peers on p-e and other metrics, we have a 12-month target price of $17.
Q: May I ask your opinion on Motorola?
A:Sure. My company follows Motorola and has a buy recommendation on the shares. We believe Motorola's challenge is to balance the expanded distribution of low-end handsets in developing countries against its goal of being a wireless innovator with high-end devices. We also believe Motorola is on track to benefit from WiMax and other hybrid planned wireless broadband networks.
Q: Can you give your 12-month outlook for Nextel Communications (NXTL )?
A:My colleague covers Nextel shares and has a buy opinion on the company. Recent results from Nextel were driven by customer additions and one of the industry's lowest customer-turnover rates. We have a 12-month target price of $39, but recognize that Nextel has agreed to be acquired by Sprint (FON ) in a deal, pending approvals, that could close in the third quarter of 2005.
Q: Is it too late to buy stocks in the wireless area?
A:We believe that there's upside potential for some stocks in this space. We have a buy opinion on the shares of both Nextel Communications and Sprint. As mentioned, these two companies are awaiting approval to complete a merger.
Q: Which outfits do you see benefiting the most from Voice over Internet Protocol?
A:We believe that VoIP will be a disruptive force in the telecom-services industry, as it will take away traditional voice-service revenues from the Baby Bells. We believe that cable companies, many of which have rolled out their cable telephony services, will be among the winners in this space.
However, we've seen regional or Baby Bell companies, such as Qwest Communications, offering their own VoIP service. And we believe that if its acquisition of AT&T goes through as planned, SBC will be a large provider of VoIP in the coming years.
Q: What's your opinion of Lucent Technologies (LU )?
A:My colleague at S&P has a hold recommendation on Lucent shares. We believe the company's cost-control focus should lead to gross margins of 43% to 45% for the next two years. With the shares priced below peers, using our forward sales estimate, we would hold Lucent shares.
Q: Do you think investors have recovered from the scandal at WorldCom?
A:We believe that telecom investors need to learn the lessons from the aforementioned WorldCom and look closely at a company's fundamentals and, in particular, its debt load. For example, we have concerns about Qwest Communications, which carries, in our view, a relatively high amount of debt, which will make growth a challenge over the next few years. However, we aren't suggesting that Qwest will need to undergo a similar bankruptcy process to WorldCom.
We still believe there are telecom services stocks worth buying, and believe investors need to look for a company with strong fundamentals, like some of the ones we mentioned earlier.