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3 Communication Stocks Set to Ride on Scalable Infrastructure Demand

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The Zacks Diversified Communication Services industry appears to be mired in demand volatility as consumers tend to switch to low-priced alternatives to tide over the coronavirus-induced adversities. Moreover, high capital expenditures for infrastructure upgrade, unpredictable raw material prices, supply-chain disruptions due to chip shortage and margin erosion due to price wars have dented the industry’s profitability.

Nevertheless, Deutsche Telekom AG (DTEGY - Free Report) , Chunghwa Telecom Co., Ltd. (CHT - Free Report) and Cincinnati Bell Inc. are likely to benefit in the long run from higher demand for scalable infrastructure for seamless connectivity amid wide proliferation of IoT, driven by faster pace of 5G deployment.


Industry Description

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.


What’s Shaping the Future of Diversified Communication Services Industry

Chip Shortfall Affecting Profitability: The industry is currently facing acute shortage of chips, which are the building blocks for various equipment used by the telecom carriers. Although President Biden has inked an executive order to launch a 100-day review process of the supply chain mechanism to address the global shortage of semiconductor chips and devise ways to increase domestic production, demand-supply imbalance has crippled operations and affected profitability due to inflated equipment prices. The government has also pledged bipartisan support for funds of $50 billion to ramp up production capacity and reduce supply bottlenecks while eliminating dependence on countries like China. However, unless the policy guidelines assume tangible effect, the industry firms are likely to face short-term challenges, affecting their cash flow.

Infrastructure Upgrade for Evolution From Legacy Networks: 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 artificial intelligence 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 home to avert being exposed to the deadly virus.

Demand Erosion as Users Shift to Low-Priced Alternatives: 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 more pronounced as the coronavirus pandemic have hurt global economic growth, triggering large-scale unemployment.

Integrated Customized Offering to Mitigate Risks: 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.


Zacks Industry Rank Indicates Bearish Trends

The Zacks Diversified Communication Services industry is housed within the broader Zacks Utilities sector. It carries a Zacks Industry Rank #228, which places it at the bottom 10% 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 bleak near-term prospects. Our research shows that the top 50% of the Zacks-ranked industries outperforms the bottom 50% by a factor of more than 2 to 1.

The industry’s positioning in the bottom 50% of the Zacks-ranked industries is a result of a negative earnings outlook for the constituent companies in aggregate. Looking at the aggregate earnings estimate revisions, it appears that analysts are losing confidence in this group’s earnings growth potential. In the past year, the industry’s earnings estimates for the current fiscal and the next fiscal have declined 8.6% and 25.7%, respectively.

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 S&P 500, Outperforms Sector

The Zacks Diversified Communication Services industry lagged the S&P 500 Index over the past year largely due to the COVID-19 woes, but outperformed the broader Zacks Utilities sector.

The industry has rallied 17.4% over this period compared with the S&P 500’s gain of 48.1% and the sector’s rally of 14.8%.

One Year Price Performance



Industry’s Current Valuation

On the basis of the trailing 12-month enterprise value-to EBITDA (EV/EBITDA), which is the most appropriate multiple for valuing telecom stocks, the industry is currently trading at 25.34X compared with the S&P 500’s 18.76X. It is also above the sector’s trailing-12-month EV/EBITDA of 20.8X.

Over the past five years, the industry has traded as high as 25.77X and as low as 6.9X and at the median of 11.45X, as the chart below shows.

Trailing 12-Month enterprise value-to EBITDA (EV/EBITDA) Ratio

3 Diversified Communication Services Stocks to Keep a Close Eye on

Deutsche Telekom AG: Headquartered in Bonn, Germany, Deutsche Telecom is one of the largest telecommunications service providers in Europe. In addition to its strong position in the domestic market, the company is likely to benefit from the accretive post-merger integration of T-Mobile US Inc. and Sprite in the United States in which it owns about 43%. The removal of forced cable TV access in multiple dwelling units in Germany through a telecom legislation is likely to help the company expand its broadband market. Moreover, an aggressive fiber rollout strategy across the country is likely to augment its domestic market hold. The Zacks Consensus Estimate for current-year earnings has been revised 23% upward over the past year. The stock carries a Zacks Rank #2 (Buy) and has gained 38.8% in the past year. You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here. It has a VGM Score of A.

Price and Consensus: DTEGY


Chunghwa Telecom Co., Ltd.: Headquartered in Taipei City, Taiwan, Chunghwa Telecom Co. is one of the largest telecommunications service providers in Asia in terms of revenues. The company secured the first 5G license of the country in June 2020 and expects to have 550,000 5G subscribers by the end of 2021. The Zacks Consensus Estimate for current-year earnings has been revised 8.4% upward over the past year. The company plans to aggressively invest in 2021 to improve its mobile communication infrastructure in order to migrate customers to higher speed services to capture incremental ARPU (average revenue per user). It has reportedly built more than 4,000 5G base stations in Taiwan. In addition, the company expects to leverage popular sports events, such as the upcoming Tokyo Olympic Games, to grow both subscriptions and revenues, including higher advertisement revenues. The stock carries a Zacks Rank #3 (Hold) and has gained 11.7% in the past year.

Price and Consensus: CHT

Cincinnati Bell Inc.: Based in Cincinnati, OH, Cincinnati Bell is a full-service regional provider of data and voice communications services over wireline and wireless networks. It also provides business customers with outsourced data center colocation operations and related managed services in world class, state-of-the-art data center facilities. The Zacks Consensus Estimate for current-year earnings has been revised 61.4% upward over the past year. The company is emphasizing on speeding up the migration of customers onto fiber network and into products like managed VoIP. The expansion of its geographic footprint in IT services has brought enhanced scale and client diversification, supporting its transformation to a hybrid IT solutions provider. Cincinnati Bell intends to continue investing in Fioptics networks to enhance customer experience and improve ARPU. Tailored TV channel packages are likely to drive top-line growth as well as check churn to traditional pay TV operators. The stock carries a Zacks Rank #3 and has a VGM Score of A. It delivered a positive earnings surprise of 21.8%, on average, in the trailing four quarters.

Price and Consensus: CBB

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