Traditionally, the telecom industry hadn't been great fodder for water cooler conversations. It has long been thought of as a boring, dividend-paying sector.
Bryan
Borzykowski is a Toronto-based business and investments writer. He’s
contributed to the New York Times, CNBC, BBC Capital, CNNMoney and
several other publications. Bryan’s also written three personal finance
books and appears regularly on CTV News.
That's changing. Over the last few years, the industry
has been undergoing a transformation, with telecom companies foraying
into content distribution, upstart wireless firms grabbing market share,
increasing digital data usage, and more.
"There are more headlines about telecom today than
there were three years ago," says Alex Zhao, an equity analyst with
Morningstar.
It's certainly a more exciting--and a more
uncertain--sector than it has been for a while. And uncertainty around
the sector's prospects have driven down the S&P 500
Telecommunications Services subindex 6.7% since January. Many of the
more traditional players in the sector have seen declines: AT&T has
fallen 3.5% year-to-date, while Verizon is down nearly 10% since the
beginning of the year as of this writing. Other parts of the telecom
market have climbed, though. Cable company Charter Communications, for
instance, is up 13% year to date.
That divergence in returns among companies is
emblematic of the difference between today's telecom sector and the
telecom sector of old.
What's Happened with Wireless?
When most investors think of telecom, they likely think of the big-name wireless companies, such as
AT&T (T), Verizon Communications (VZ), Sprint (S), and T-Mobile US (TMUS). There's plenty of change afoot here.
Years ago, AT&T and Verizon dominated the sector,
and while they're still the largest players, their once-large moats have
diminished as T-Mobile and Sprint have started taking market share.
(Morningstar currently assigns a narrow moat rating to the former two
companies and a no moat rating to the latter two.) That has impacted
their pricing power, says Zhao. T-Mobile, for example, has introduced an
unlimited data package, something the bigger carriers haven't wanted,
but are now forced to do.
It's also unclear how the content play that some wireless firms have been engaging in will work out. If AT&T's purchase of Time Warner (TWX)
goes through, it will own a lot of high-quality programming, such as
HBO's lineup, which could allow it to generate advertising revenues and
reduce the price it pays to show content on its various platforms. It
may also give subscribers content-specific benefits, similar to how
AT&T provides customers free data streaming for DirectTV Now.
(AT&T purchased the satellite business in 2014.) However, Zhao
doesn't think the bundling model will give these companies a sustainable
edge, because competitors can also start offering content for free. For
instance, T-Mobile gives customers who switch from AT&T a year's
free credit for a DirectTV Now subscription.
The cellphone market is also fairly saturated.
According to research site Statista, the number of U.S. wireless
subscribers grew by just 5.4% year-over-year in the fourth quarter of
2016. Increasing competition, weaker pricing and slow growth doesn't say
screaming buy, at least not in the near term, says Paul Greene, manager
of the Bronze-rated T. Rowe Price Media & Telecommunications (PRMTX).
"The competitive environment in the U.S. wireless
industry has gotten worse for the large incumbents," he says, though he
does note that he has a sizable portion in T-Mobile, which is growing
faster than the others.
Saying all that, buy and hold dividend investors may
still be drawn to these companies, says Greene. They offer good
payouts--AT&T has a trailing 12-month yield of 4.8%, while Verizon
is yielding 4.85%. Like other dividend payers, these stocks may
underperform in a rising rate environment--but the dividend is still
attractive nonetheless.
Better Prospects in Cable and Towers
For investors who want more growth--and perhaps more upside--managers agree that there are two areas to look at within telecom: broadband cable and cellphone towers. The former, which includes companies such as Charter Communications and Comcast (CMCSA),
has been taking market share from traditional wireline operators that
transmit cable over a copper line. Broadband cable is delivered over the
internet and is a much faster delivery system than wireline, says Scott
Walker, an analyst with MFS Investment Management, who contributes
telecom ideas to the Silver-rated MFS Utilities (MMUFX).
"It's really winning that race consistently," he says.
Broadband is also Netflix-proof. Since the internet is
also delivered over broadband, even if someone cuts the cable cord,
they'll need a fast and reliable connection to stream movies.
"If you ditch your cable bundle, you still need some way to consume Netflix (NFLX)," says Walker. "So your faster speed alternative will be (broadband) and that reinforces the bet in the long-run."
Both Walker and Greene are also fans of tower
companies, which are physical towers that transmit wireless signals to
cellphones. They charge carriers a fee for use of their towers, and that
fee can increase as consumers consume more data. Companies in this
subsector, such as SBA Communications (SBAC) and American Tower (AMT), typically raise prices by inflation or 3%, whichever is higher, says Walker.
As people use more data--Americans are expected to
increase their data consumption by 535% between now and 2021, according
to a 2016 Ericsson Mobility report--tower
companies could start seeing double-digit revenue growth, says Walker.
Greene thinks the sector will see strong internal rates of return, too.
"We can see compound returns grow at double digit rates with a lot of visibility and without much variation," he says.
Pick Your Spots--and Mind the Uncertainty
Currently, the telecom sector is just slightly undervalued according to Morningstar, trading at 0.96 fair valuation ratio. A few names are trading in 4-star range, suggesting they're undervalued by Morningstar's metrics: CenturyLink (CTL), Frontier Communications (FTR), and Windstream Holdings (WIN).
However, investors in this sector should pay close
attention to uncertainty ratings, which vary by company. Despite the
pressure on the traditional telecoms, AT&T and Verizon both earn
medium uncertainty ratings, because they're still large companies that
generate plenty of cash, says Zhao. However, CenturyLink, Frontier
Communications, and Windstream Holdings all carry high or very high
uncertainty ratings due, in part, to increasing competition in the cable
sector.
While several Morningstar Medalist funds hold telecom
stocks, Greene's T. Rowe Price fund is the only telecommunications fund
that earns a medalist rating. Some other telecom-focused mutual funds
and ETFs include Fidelity Select Telecommunications (FSTCX), iShares US Telecommunications (IYZ), S&P Telecom ETF (XTL), and Vanguard Telecommunication Services ETF (VOX).
Bryan Borzykowski is a freelance columnist for
Morningstar.com. The views expressed in this article do not necessarily
reflect the views of Morningstar.com.
When most investors think of telecom, they likely think of the big-name wireless companies, such as
AT&T (T), Verizon Communications (VZ), Sprint (S), and T-Mobile US (TMUS). There's plenty of change afoot here.
Years ago, AT&T and Verizon dominated the sector,
and while they're still the largest players, their once-large moats have
diminished as T-Mobile and Sprint have started taking market share.
(Morningstar currently assigns a narrow moat rating to the former two
companies and a no moat rating to the latter two.) That has impacted
their pricing power, says Zhao. T-Mobile, for example, has introduced an
unlimited data package, something the bigger carriers haven't wanted,
but are now forced to do.
It's also unclear how the content play that some wireless firms have been engaging in will work out. If AT&T's purchase of Time Warner (TWX)
goes through, it will own a lot of high-quality programming, such as
HBO's lineup, which could allow it to generate advertising revenues and
reduce the price it pays to show content on its various platforms. It
may also give subscribers content-specific benefits, similar to how
AT&T provides customers free data streaming for DirectTV Now.
(AT&T purchased the satellite business in 2014.) However, Zhao
doesn't think the bundling model will give these companies a sustainable
edge, because competitors can also start offering content for free. For
instance, T-Mobile gives customers who switch from AT&T a year's
free credit for a DirectTV Now subscription.
The cellphone market is also fairly saturated.
According to research site Statista, the number of U.S. wireless
subscribers grew by just 5.4% year-over-year in the fourth quarter of
2016. Increasing competition, weaker pricing and slow growth doesn't say
screaming buy, at least not in the near term, says Paul Greene, manager
of the Bronze-rated T. Rowe Price Media & Telecommunications (PRMTX).
"The competitive environment in the U.S. wireless
industry has gotten worse for the large incumbents," he says, though he
does note that he has a sizable portion in T-Mobile, which is growing
faster than the others.
Saying all that, buy and hold dividend investors may
still be drawn to these companies, says Greene. They offer good
payouts--AT&T has a trailing 12-month yield of 4.8%, while Verizon
is yielding 4.85%. Like other dividend payers, these stocks may
underperform in a rising rate environment--but the dividend is still
attractive nonetheless.
Better Prospects in Cable and TowersFor investors who want more growth--and perhaps more upside--managers agree that there are two areas to look at within telecom: broadband cable and cellphone towers. The former, which includes companies such as Charter Communications and
Comcast (CMCSA),
has been taking market share from traditional wireline operators that
transmit cable over a copper line. Broadband cable is delivered over the
internet and is a much faster delivery system than wireline, says Scott
Walker, an analyst with MFS Investment Management, who contributes
telecom ideas to the Silver-rated MFS Utilities (MMUFX).
"It's really winning that race consistently," he says.
Broadband is also Netflix-proof. Since the internet is
also delivered over broadband, even if someone cuts the cable cord,
they'll need a fast and reliable connection to stream movies.
"If you ditch your cable bundle, you still need some way to consume Netflix (NFLX)," says Walker. "So your faster speed alternative will be (broadband) and that reinforces the bet in the long-run."
Both Walker and Greene are also fans of tower
companies, which are physical towers that transmit wireless signals to
cellphones. They charge carriers a fee for use of their towers, and that
fee can increase as consumers consume more data. Companies in this
subsector, such as SBA Communications (SBAC) and American Tower (AMT), typically raise prices by inflation or 3%, whichever is higher, says Walker.
As people use more data--Americans are expected to
increase their data consumption by 535% between now and 2021, according
to a 2016 Ericsson Mobility report--tower
companies could start seeing double-digit revenue growth, says Walker.
Greene thinks the sector will see strong internal rates of return, too.
"We can see compound returns grow at double digit rates with a lot of visibility and without much variation," he says.
Pick Your Spots--and Mind the UncertaintyCurrently, the telecom sector is just slightly undervalued according to Morningstar, trading at 0.96 fair valuation ratio. A few names are trading in 4-star range, suggesting they're undervalued by Morningstar's metrics:
CenturyLink (CTL), Frontier Communications (FTR), and Windstream Holdings (WIN).
However, investors in this sector should pay close
attention to uncertainty ratings, which vary by company. Despite the
pressure on the traditional telecoms, AT&T and Verizon both earn
medium uncertainty ratings, because they're still large companies that
generate plenty of cash, says Zhao. However, CenturyLink, Frontier
Communications, and Windstream Holdings all carry high or very high
uncertainty ratings due, in part, to increasing competition in the cable
sector.
While several Morningstar Medalist funds hold telecom
stocks, Greene's T. Rowe Price fund is the only telecommunications fund
that earns a medalist rating. Some other telecom-focused mutual funds
and ETFs include Fidelity Select Telecommunications (FSTCX), iShares US Telecommunications (IYZ), S&P Telecom ETF (XTL), and Vanguard Telecommunication Services ETF (VOX).
Bryan Borzykowski is a freelance columnist for
Morningstar.com. The views expressed in this article do not necessarily
reflect the views of Morningstar.com.