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Diversified Communication Industry Outlook on Firm Footing

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The Zacks Diversified Communication Services industry comprises firms that provide a wide array of communication services, including wireless, wireline and Internet (broadband, dial-up and entertainment), to business enterprises and consumers. These companies offer mobile and wireline telephone services along with high-speed Internet, direct-to-home satellite television, Voice over Internet Protocol (VoIP) and other value-added services. In addition to providing integrated information and communications technology services to businesses and governments, some of these companies operate as local exchange carrier or full-service provider of data center colocation and related managed services in state-of-the-art data center facilities. Some industry participants also provide IP networks, private lines, network management and hosting services along with the sale, installation and maintenance of major branded IT and telephony equipment.

Here are the three major themes in the industry:

•    Video and other bandwidth-intensive applications have witnessed exponential growth owing to the wide proliferation of smartphones and increased deployment of the superfast 5G technology. This has forced the industry participants to invest considerably in LTE, broadband and fiber to provide additional capacity and ramp up the Internet and wireless networks. These companies are rapidly transforming themselves from legacy copper-based telecommunications firms to technology powerhouses, with capabilities to meet the growing demand for flexible data, video, voice and IP solutions. At the same time, the industry participants continue to focus on leveraging wireline momentum, expanding media coverage, improving customer service and achieving a competitive cost structure to generate higher average revenue per user while attracting new customers. Also, these firms are offering the flexibility to better manage data traffic by leveraging indigenous software-defined networks to enable low-latency, high-bandwidth applications for faster access to data processing. Utilizing machine learning techniques and AI capabilities, these networks are likely to transform the way data-intensive images and videos are transferred across the industry on a real-time basis. All these efforts have particularly helped firms in the industry to cater to the upsurge in data demand, with digital sustainability becoming the norm of the day as majority of the population is forced to work from the safety of their homes to avert being exposed to the deadly virus.

•    Efforts to offset substantial capital expenditure for upgrading network infrastructure by raising fees have led to reduced demand, as customers tend to switch to lower-priced alternatives. Moreover, the local-line access for traditional telephony service continues to face a decline among large customers due to higher wireless substitution and migration to IP-based services. This is reflected in the persistent erosion in overall network access services on a year-over-year basis, hurting revenues of local and long-distance operations. With Digital Subscriber Line and cable modems gaining widespread acceptance, customers are deactivating extra phone lines that were earlier used to access the Internet via dial-up modem. In addition, a shift toward wireless services and the aggressive rollout of VoIP and long-distance services by Tier-1 competitors have resulted in access line erosion. These negative impacts have become all the more pronounced as the coronavirus pandemic continues to spook financial markets in one of the worst declines in the recent past, hurting economic growth and triggering large-scale unemployment.

•    In order to improve profitability, the companies are increasingly focusing on providing support services to various small and mid-sized businesses (SMBs) with an integrated portfolio of voice, data and technology services. The firms are tailoring their services to suit individual business needs and are facilitating SMBs to better adapt themselves to necessary technology advancements. At the same time, the industry is battling hard to mitigate operating risks, stemming from volatility in demand, unpredictable business environment led by the virus outbreak and challenging geopolitical scenario, by offering free services to low-income families and seamless wireless connectivity to the masses.

Overall, the industry appears poised to benefit from healthy growth dynamics, favorable factors and inherent sector strength despite the coronavirus-induced adversities.

Zacks Industry Rank Indicates Bullish Prospects

The Zacks Diversified Communication Services industry is housed within the broader Zacks Utilities sector. It carries a Zacks Industry Rank #116, which places it at the top 46% of more than 250 Zacks industries.

The group’s Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates encouraging near-term prospects. Our research shows that the top 50% of the Zacks-ranked industries outperform the bottom 50% by a factor of more than 2 to 1. The industry’s positioning in the top 50% of the Zacks-ranked industries is a result of a positive earnings outlook for the constituent companies in aggregate.

Before we present a few diversified communication stocks that are well positioned to outperform the market based on a relatively modest earnings outlook, let’s take a look at the industry’s recent stock market performance and valuation picture.

Industry Lags Sector & S&P 500

The Zacks Diversified Communication Services industry has lagged the broader Zacks Utilities sector and the S&P 500 Index over the past year.

The industry has declined 18% over this period compared with the sector’s fall of 7.2% and against the S&P 500’s rise of 16.2%.

One Year Price Performance

Industry’s Current Valuation

On the basis of trailing 12-month enterprise value-to EBITDA (EV/EBITDA) ratio, which is the most appropriate multiple for valuing telecom stocks, the industry is currently trading at 11.75X compared with the S&P 500’s 12.76X. It is also trading below the sector’s trailing-12-month EV/EBITDA of 17.98X.

Over the past five years, the industry has traded as high as 14.27X, as low as 7.05X and at the median of 11.35X, as the chart below shows.

Trailing 12-Month Enterprise Value-to EBITDA (EV/EBITDA) Ratio

Bottom Line

The industry is well poised to benefit from the continued deployment of 5G technologies, fiber optics and massive proliferation of data traffic despite adversities. However, issues related to the global coronavirus pandemic and tense global geopolitical conditions remain latent threats.

None of the stocks in the space currently sports a Zacks Rank #1 (Strong Buy). You can see the complete list of today’s Zacks #1 Rank stocks here.

We are presenting two Zacks Rank #2 (Buy) stocks that appear to be solid investment propositions.

Deutsche Telekom AG (DTEGY - Free Report) : Headquartered in Bonn, Germany, this leading diversified communication services provider from Europe has gained 5.5% in the past year. The company has a long-term earnings growth expectation of 7% and a VGM Score of A. The Zacks Consensus Estimate for current fiscal-year earnings has increased 18.9% since April-end.
 
Price and Consensus: DTEGY



VEON Ltd. (VEON - Free Report) : Headquartered in Amsterdam, the Netherlands, this diversified communication services provider has a long-term earnings growth expectation of 12.6% and a VGM Score of B. The Zacks Consensus Estimate for current fiscal-year earnings has remained stable over the past three months.

Price and Consensus: VEON



We are also presenting two stocks with a Zacks Rank #3 (Hold) that investors may currently hold on to.

Swisscom AG (SCMWY - Free Report) : Based in Switzerland, this diversified communication services provider has gained 10.4% in the past year. The stock has a VGM Score of B. The Zacks Consensus Estimate for current fiscal-year earnings has increased 3.3% since April-end.

Price and Consensus: SCMWY



Telenor ASA (TELNY - Free Report) : Based in Norway, this diversified communication services provider has a long-term earnings growth expectation of 26.3%. The Zacks Consensus Estimate for current fiscal-year earnings has increased 22.2% since March-end.

Price and Consensus: TELNY



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