Are We Seeing a Cell Turnaround?

Todd Rosenbluth, S&P's telecom equity analyst, has a neutral outlook on wireless telecommunications, despite a solid 2007 so far

While flipping through the rolling 12-month relative strength charts for the 138 subindustries in the Standard & Poor's Composite 1,500 index (which consists of the large-cap S&P 500, MidCap 400 and SmallCap 600 indices), I noticed a smooth-looking turnaround in momentum for the S&P Wireless Telecom group. Year-to-date through June 20, the subindustry index rose 16.2%, vs. an 8.6% advance for the S&P 1,500 index. In 2006, the subindustry index was down 1.1%, vs. a 13.3% advance for the broader market.

Wondering if this was a turning point for the subindustry, I retrieved the fundamental outlook on the group from S&P's Advisor Insight service. Todd Rosenbluth is S&P's equity analyst for the wireless telecom group, and this is his most recent review of the group's prospects.

"Our fundamental outlook for the wireless telecommunications subindustry for the next 12 months is neutral, as we believe major wireless service providers in developed countries will have stable cash flow despite high wireless market penetration in their territories, while wireless providers in emerging markets should continue to realize double-digit subscriber and revenue growth in 2007 with improving margins and profitability."

Slight Premium to Peers

"We see increased pricing pressure in the U.S. wireless market this year, with available funds directed more to sales and marketing to retain or acquire new subscribers. Also, there are increasing differences among the four national wireless carriers. With Cingular Wireless (T) and Verizon Wireless (VZ, VOD) moving significantly ahead of their peers in market share and aided by new handsets, we believe there are competitive risks that Sprint Nextel (S) and T-Mobile USA (DT) will aggressively price their services and products to regain lost market share.

"In May 2007, Alltel's directors approved the sale of the company to private equity firms for $27.5 billion, subject to necessary approvals. We estimate the proposed buyout of Alltel (AT) is at eight times our 2008 EBITDA estimate, a slight premium to peers. In our view, other smaller carriers are trading at similarly high multiples, given the scarcity of investments.

"While 2007 EBITDA and net earnings should increase in the mid- to high-single digits compared to the historical double-digit rate, we see opportunities to use rising free cash flow to invest in advanced technologies, especially broadband wireless data and video services. Strong promotion of family plans has leveled off [average revenue per user], but has resulted in lower monthly customer churn to date."

Competitive Risk

"In emerging wireless markets, we continue to see double-digit subscriber and revenue growth. In 2007, wireless carriers are investing in their networks mostly for geographic expansion, but in many cases, wireless carriers are investing in 3G-enhanced networks.

"We view mobile WiMAX as a competitive risk to the incumbent wireless providers with the startup of new carriers such as Clearwire (CLWR), which recently went public. Sprint Nextel also plans to invest $3 billion in a new WiMAX network in the next two to three years."

The market-weighted average S&P STARS ranking is 2.3 (vs. 3.7 for the S&P 1,500 Index). There are three companies in the S&P 1,500 Wireless Telecommunications Services subindustry index: Alltel (AT; $67; ranked hold), Sprint Nextel (S; $22; ranked sell), and Telephone & Data Systems (TDS; $72; ranked sell). Non-index members include China Mobile (CHL; $59; ranked buy), Vodafone (VOD; $33; ranked hold), and China Unicom (CHU; $18; ranked sell).

Despite the group's improving relative strength, it appears as if the fundamental outlook does not support this optimism.

Industry Momentum List Update

Here is this week's list of the industries in the S&P 1,500 with Relative Strength Rankings of five (price performances in the past 12 months that were among the top 10% of subindustries in the S&P 1,500), along with a stock with the highest S&P STARS (tie goes to the highest market value).

Subindustry Company S&P STARS Rank Price (7/20/07)
Auto Parts & Equipment Johnson Controls (JCI) 3 $119
Commercial Printing R.R. Donnelley (RRD) 4 $45
Commodity Chemicals Lyondell Chemical (LYO) 3 $47
Computer Hardware Apple (AAPL) 3 $144
Construction & Engineering Jacobs Engineering (JEC) 5 $66
Construction & Farm Machinery Trinity Industries (TRN) 5 $46
Construction Materials Vulcan Materials (VMC) 2 $103
Diversified Metals & Mining Freeport McMoRan Copper (FCX) 2 $99
Fertilizers & Agr. Chem. Monsanto (MON) 3 $69
Internet Retail (AMZN) 2 $72
Semiconductor Equipment MKS Instruments (MKSI) 5 $27
Steel Quanes (NX) 4 $53
Technology Distributors Arrow Electronics (ARW) 3 $39
Tires & Rubber Goodyear Tire (GT) 2 $35
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