Published May 31st, 2018 by Jonathan Weber
The telecommunications sector has a longer history than most people realize.
AT&T (T) can trace its roots, for example, back to the founding of Bell Telephone Company in 1877.
The sector has changed a lot since 1877, and with new trends such as mobile phones, the internet, the emergence of cable TV and other developments telecommunications companies are active in many more areas than they were a century ago.
Today, the telecommunications sector is categorized by high capital investment, sluggish growth, and generous dividend payments. In short, the telecommunications sector is mature. You can download a list of all 138 telecommunications sector stocks below:
In this article we will look at five major dividend-paying telecommunications companies that we believe will produce attractive returns (especially the 3 highest ranked stocks in this article). The companies are ranked by total return potential over the coming five years.
Rankings data is courtesy of our Sure Analysis Research Database.
Telecom Stock #5: Telephone & Data Systems (TDS)
Telephone & Data Systems, which was founded in 1969, is by far the smallest company we will look at in this article, trading at a market capitalization of ‘just’ $2.9 billion. It offers cellular (~77% of sales) and landline services, as well as wireless products, cable, broadband and voice services to customers in 34 states.
During the most recent quarter Telephone & Data Systems was able to grow its revenues by 2% (year-over-year), the biggest revenue contributor was U.S. Cellular, which is majority owned (83%) by Telephone & Data Systems.
U.S. Cellular saw negative net additions during Q1, but nevertheless it was able to grow its revenues per user and its revenues per account both year-over-year as well as compared to Q4 2017. Through lower expenses U.S. Cellular’s profits grew by 13% year-over-year, which was one of the main reasons for Telephone & Data Systems’ better than expected profitability during Q1 (the company earned $0.05 per share, analysts had expected a loss).
Over a longer period of time Telephone & Data Systems’ profit growth is not convincing, the company earned less in 2017 than in 2008, and 2018 will be a down year again. We see positive growth starting in 2019, primarily due to the positive contribution from U.S. Cellular, but earnings growth will remain at a relatively muted level going forward. Our estimate is that EPS will grow by 3% annually in the 2018-2023 time frame.
Telephone & Data Systems has been growing its book value much more consistently (compared to its earnings growth) over the last decade, and book value per share will in all likelihood hit a new all-time high in 2018. Relative to its book value shares of the company are quite inexpensive (trading at a price to book of 0.74), and we see valuation expansion potential over the coming years.
Telephone & Data Systems has recently reversed the trend of rising debt levels, and with stabilizing profits (relative to its asset base) its fundamentals don’t look too bad. Through a combination of its dividend yield (2.5%), positive long term growth (~3% annually) and some valuation expansion (~2% annually) the company has a good chance of delivering total returns of roughly 8% a year going forward.
Telecom Stock #4: BCE Inc. (BCE)
BCE is a Canadian telecommunications and media company that was founded in 1970 and that operates through the Bell Wireless, Bell Wireline and the Bell Media units.
BCE’s Q1 results looked very solid as the company was able to grow its revenues as well as its earnings compared to the first quarter of the previous year.
Source: BCE Earnings Presentation
BCE was able to grow its customer base once again, adding more than 100,000 new customers across its wireless, Internet and IPTV segments. BCE was also able to lower its churn rate and to increase billings per user over the last year, the combination allowed for solid mid-single digits revenue and earnings growth.
BCE is attractive for its existing customers (which is why the churn rate is relatively low) as well as for new customers (which explains the net adds) due to offering the best network in Canada. High-quality service is a major competitive advantage for BCE. It would cost its competitors billions to upgrade its network to the same quality as BCE’s.
Debt levels have been rising over the last decade, and BCE’s dividend payout ratio is high relative to its profits (the company forecasts a 87% payout ratio in 2018), but thanks to strong cash generation its dividend (which yields 5.7%) looks sufficiently safe, as BCE targets a free cash flow payout ratio of ~70%.
Over the last decade BCE grew its profits by about 3% annually, for 2018 the company’s own forecasts see earnings per share growth of 14%. Even though the earnings growth rate will normalize over the coming years and likely fall more in line with BCE’s historic earnings growth, the total return outlook for BCE’s investors is not bad at all.
BCE trades at a small discount to fair value, the combination of some valuation expansion (~1% annually), earnings per share growth (~3% annually) and its high dividend yield of 5.7% will, according to our estimates, lead to total returns of 9% to 10% annually over the coming five years.
US based investors should note that Canada imposes a 15% dividend withholding tax. Investing in Canadian stocks through retirement accounts and filing the necessary paperwork can remove this dividend withholding tax burden.
Telecom Stock #3: Comcast (CMCSA)
Comcast is a bit different from the other four companies in this article, as it is not a telecommunications company that is focused on wireless services. Rather, Comcast generates the majority of its revenues from cable services. It also operates in other segments such as broadcast television, filmed entertainment and theme parks. Comcast was founded in 1963 and is one of the biggest media companies in the world, based on its market cap of $146 billion.
Source: Comcast Earnings Presentation
Comcast’s most recent results saw strong earnings per share growth due in large part to tax reform gains. Growth will continue through the rest of 2018 and then normalize starting in 2019 as the company’s tax rate will not decline further.
We see Comcast generating 6%-7% earnings per share growth over the coming years, primarily through a combination of low-single-digit revenue growth and share repurchases, which are possible thanks to Comcast’s strong cash generation.
Future margin increases (which helped Comcast achieve significantly higher earnings growth in the past) will be harder to achieve, as programming and content costs are rising, which has made operating income growth fall nearly in line with revenue growth in the recent past. Revenue growth will be limited due to the impact of cord-cutting, although higher growth rates in the film entertainment, theme parks and broadcast TV segments should mitigate that effect.
Comcast’s total liabilities have been rising over the last years, but its leverage has declined due to equity growing at a faster rate. The company is not overleveraged, as interest coverage is at a solid level and has been improving further over the last couple of years.
The company has been increasing its dividend aggressively over the last decade, raising the payout from $0.14 per share to $0.76 per share, but its payout ratio is still not high at all at just 31%, which is why investors can expect that the dividend will continue to grow at an attractive pace over the coming years.
Comcast’s low valuation makes it a cheap dividend stock. Shares trade at just 13.5 times this year’s earnings, which is a significant discount to its historic valuation.
According to our estimates a combination of valuation upside (~2.5% a year), earnings per share growth (we forecast ~6.5% annually) and a dividend yield of 2.4% should provide compelling total returns of 11% to 12% annually over the next five years.
Telecom Stock #2: Verizon Communications (VZ)
Verizon Communications (which was created through a merger in 2000) is valued at $201 billion, almost exactly in line with its peer AT&T. Verizon offers services such as broadband and cable, but wireless is, by far, the most important business for Verizon. The wireless segment geenrates 75% of its revenues, and Verizon is the biggest wireless carrier in the US.
Source: Verizon Earnings Presentation
Verizon’s first quarter results showed a strong EPS growth rate of 23%, but almost all of that was based on a substantially lower tax rate. Adjusted for the tax legislation changes, Verizon would have grown its EPS by just 1% versus the prior year’s quarter. That is not necessarily dramatic, but it shows that investors should assume single-digit profit increases (over the last decade EPS were grown by 5% annually on average) from Verizon beyond 2018, once the tax rate change is lapped.
Verizon’s leverage is relatively high. Liabilities are as high as ~80% of all assets, but Verizon is working on lowering its debt levels, and has successfully done so over the last few years (debt to assets stood at 94% during 2014). Due to higher cash flows in 2018 and beyond (tax change impact) Verizon should have more room to pay down debt in addition to continuing to grow its dividend. The company’s dividend safety is analyzed in detail in the video below.
Verizon’s 4.9% dividend yield (the dividend was grown by 2%-3% a year over the last decade) is a key factor for total returns going forward, additional contributions will come from earnings per share growth (~5% annually) and from the fact that Verizon trades at a discount to its historic valuation.
Based on forecasts for 2018 Verizon is currently trading at 12 times earnings, whereas shares used to trade at roughly 14 times earnings on average over the last decade. Sure Analysis therefore forecasts a 3% annual valuation expansion tailwind, which gets us to a total return estimate of roughly 13% annually over the coming five years.
Telecom Stock #1: AT&T (T)
AT&T is marginally bigger than Verizon (at the time of writing) in terms of market capitalization. The company offers communications and digital entertainment services, such as internet access, TV and wireless services. AT&T offers its services in the US, but it also operates sizeable businesses in other parts of the world such as Mexico and South America.
AT&T’s impressive dividend history helps it to stand out from its peers as an investment. AT&T is a Dividend Aristocrat, a select group of 53 S&P 500 stocks with 25+ years of consecutive dividend increases.
AT&T’s dividend safety is analyzed in detail in the below video.
AT&T is attempting to acquire Time Warner to become a more integrated media company. The acquisition would give AT&T access to strong, well-received content. The outcome of the acquisition (which was announced in late 2016) is still unsure due to regulatory issues. AT&T is not waiting around for the acquisition to move towards growth.
AT&T reported strong earnings per share growth during the most recent quarter; recording a 15% year-over-year increase. The bulk of this increase was due to the impact of a lower tax rate. The company nevertheless is making progress operationally.
Source: AT&T Earnings Presentation
AT&T continues to add new users for both postpaid and prepaid phones, which has helped increase revenues for AT&T mobility – the biggest and most important one of AT&T’s businesses.
AT&T is, however, negatively impacted by weaknesses in its Entertainment Group, which saw lower revenues as well as lower margins in the most recent quarter (compared to the prior year’s first quarter). This is due to the cord-cutting trend that hurts AT&T’s revenue per user in the entertainment segment – despite a strong pace of net adds its revenues declined by $1 billion year over year, as DIRECTV NOW additions come at lower revenues per customer than its traditional linear video subscriptions.
AT&T is making progress with its international business. its Mexican business generated 21% revenue growth in Q1, but due to the still quite small size (relative to the US business) the international business is not yet strong enough to completely mitigate weaknesses in AT&T’s domestic operations.
Thanks to a focus on cost controls AT&T will, according to our estimates, still be able to grow its earnings by a mid-single-digit pace over the coming years, even if revenue growth is subdued. If the acquisition of Time Warner gets approved, AT&T’s growth outlook would be better, but that is, at the moment, relatively speculative.
Uncertainty around the Time Warner acquisition and worries about AT&T’s debt levels (even though the debt to assets ratio has declined during 2017) are why AT&T’s shares currently trade at a discount to their historic valuation, changing hands for just 9.4 times this year’s earnings.
The combination of this discount to its historic valuation (which, we believe, allows for multiple expansion that will be a ~5% annual total return tailwind), some earnings per share growth (~5% annually) and its high dividend yield of 6.2% has the potential for strong total returns of roughly 16% annually over the coming years.