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U.S. Telecommunications Industry Outlook - March 2018

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The U.S. Telecommunications industry had a disappointing 2017. However, signs of improvement were apparent from fourth-quarter 2017 with most of the major telecom stocks starting to perform well. Notably, all four national wireless carriers have gained postpaid subscribers in the last reported quarter.

Postpaid customers are those billed monthly and considered more profitable to telecom operators. Interestingly, all five major wireless operators have gained considerable postpaid customers despite cut-throat pricing competition in the industry resulting in unlimited data plans with several sweeteners. We believe this trend is likely to continue in 2018.

T-Mobile US Inc. (TMUS - Free Report) , Verizon Communications Inc. VZ, AT&T Inc. T and Sprint Corp. S have gained substantial postpaid customers. Additionally, a new entrant in the wireless space, Comcast Corp. CMCSA, a cable MSO (Multi Service Operator), also gained significant postpaid subscribers. Each of these stocks currently carry a Zacks Rank #3 (Hold). You can seethe complete list of today’s Zacks #1 Rank stocks here.

Upcoming 5G Wireless Network

Fifth-generation (5G) superfast wireless networks will provide primary impetus to the telecom industry. In September 2017, Moody's Investors Service stated in a report that the evolution towards 5G wireless networks will result in higher capital spending for the U.S. wireless carriers. Per a report by research firm iGR, U.S. telecom operators will spend around $104 billion between 2015 and 2025 to upgrade existing 4G networks to the upcoming 5G standards and consequently, execute full installation of 5G wireless services.

We expect wireless networks to provide primary impetus to the telecom industry. In this regard, Internet of Things (IoT) has the potential to emerge the numero uno factor for future growth in the space. According to a report by research firm International Data Corporation (IDC), worldwide spending on IoT will grow at 19.2% compound annual growth rate to nearly $1.7 trillion in 2020 from $698.6 billion in 2015.

Major Positives

Several positives have emerged for the industry since the last quarter of 2017. President Trump’s proposed policy changes have made the overall economic outlook fairly bullish. The two pro-growth agendas – a significant cut in the corporate tax rate and deregulation – are major catalysts to the U.S. economy.  Trump has stated that he wants to do away with nearly 75% of all governmental regulations during his term. We believe that Telecom will be one of the major beneficiaries of this policy change.

On Dec 14, 2017, in a landmark decision, the U.S. telecom regulator Federal Communications Commission (“FCC”) repealed the Net Neutrality laws that it had imposed under the Obama administration. There is little doubt that the ISP industry will be the major beneficiary after the repeal of Net Neutrality. Lenient regulatory attitudes at the current FCC may also pave the way for new merger and acquisition deals between ISPs and online digital media companies.

The proposal to reduce corporate tax rate from 35% to 21% would be immediately accretive to cash flowof the telecom carriers. Trump’s tax proposal will result in a huge windfall for telecom operators. The carriers can utilize this money for 5G network R&D and deployment. 

The telecom industry is highly capital-intensive in nature. Therefore, the immediate expensing of investment in all tangible, intangible and real property (other than land) would significantly benefit telecom carriers. This would encourage telecom operators to increase investment for capital expenditure. Major proposals such as a pledge to spend $1 trillion in infrastructure projects over a period of 10 years, along with the above-mentioned policy changes, are likely to spur higher consumer spending. 

High Dividend Yields

One of the easiest ways for any company to raise shareholder wealth is to hike the dividend rate. Telecom companies offer one of the highest dividend yields in the U.S. economy.

Typically, well established, profitable companies pay dividends. Investors seeking income-producing (dividends) stocks are well served by growth and income-oriented companies, i.e., companies with stable earnings growth that pay a solid dividend.

Unlike other industries, U.S. telecom operators generate revenues predominantly in the country. This makes these stocks less susceptible to volatility in the foreign exchange rate as well as macro-economic fluctuations plaguing the rest of the world. As the U.S. economy is growing steadily, supported by strong data of various macro-indicators, many of these large companies are likely to generate massive cash but because of their size, may not have growth opportunities they once had. For that reason, high dividend-yielding companies will be attractive for investors.

Product Differentiation

A growing economy acts as a catalyst to the demand for real-time voice, data and video. The escalation in demand has encouraged telecom service providers to undertake large network extensions while upgrading plans. The rising demand for technologically superior products has been a silver lining for the telecommunication industry in an otherwise tough environment.

The telecommunications industry is witnessing rapid technological improvements. Unprecedented growth in high-speed mobile Internet traffic, particularly with respect to wireless data and video, has transformed this industry into an ever evolving, inventive and keenly contested space.Moreover, wireless operators are quickly moving toward digital media platform offering online TV streaming services, resulting in innovative product differentiation on the part of wireless carriers.

Valuation Indicates Strong Upside

Going by the P/E (price to earnings per share) valuation metrics, which is often used to value telecom sector stocks, the industry looks stable at this stage. The industry currently has a trailing 12-month P/E ratio of 14.57x, which is below the median value of 14/90x and the S&P 500’s trailing 12-month P/E ratio of 21.27x.

Additionally, the reading compares favorably with the market at large, as the current P/E for the S&P 500 is pegged at 18.14x and the median level is 18.56x. Meanwhile, current P/E of the telecom industry is 11.84x with a median of 12.32x. Consequently, at present, the telecom industry looks undervalued compared with the overall market. This indicates a near-term upside potential for the stocks.

Another commonly used valuation metric for this sector is P/S (price to sales) which also depicts the same picture. The industry’s current P/S of 1.32x compares favorably with the market at large, as the current P/S for the S&P 500 is at 3.41x and the median level is 1.35x.

What the Zacks Industry Rank Indicates?

Within the Zacks Industry classification, Telecommunications is broadly grouped in the Computer and Technology sector (one of the 16 Zacks sectors) and is further sub-divided into 12 industries at the expanded level: Communications Infrastructure, Communications Components, Satellite Communications, Cable TV, Diversified Communications Services, Internet Services, Wireless Equipment Supplier, National Wireless Service Provider, Rural Wireline Operator, Non-U.S. Wireless Operator, National Wireline Operator and Non-U.S. Wireline Operator.  The level of sensitivity and exposure to different stages of the economic cycle vary for each industry.

We rank 265 industries in the 16 Zacks sectors, based on the earnings outlook and fundamental strength of the constituent companies in each industry. We put our industries into two groups: the top half (industries with the best average Zacks Rank) and the bottom half (the industries with the worst average Zacks Rank). Over the last 10 years, using a one-week rebalance, the top half beat the bottom half by a factor of more than 2 to 1. (To learn more visit: About Zacks Industry Rank.)

Earnings Trend in the Sector

The broader Technology sector, of which the telecommunications industry is part, delivers a strong show with respect to earnings. So far, 98.4% of sector participants have reported fourth-quarter 2017 financial results, which have been impressive in terms of beat ratios (percentage of companies coming up with positive surprises).

Total earnings have shown a strong 23.6% year-over-year increase on a 10.9% rise in revenues. This compares favorably with earnings growth of 21.3% in the third quarter of 2017. Revenues witnessed a rise of 8.8% in the second quarter.

However, the consensus earnings expectation for the next two quarters depicts a lukewarm trend. While earnings growth is anticipated to grow 19.9% in the first quarter of 2018, it is likely to grow 19.2% in the second quarter of 2018. Similarly, revenue is expected to grow 11.4% in the first quarter of 2018 and 9.2% in the second quarter of 2018.

For a detailed look at the earnings outlook for this sector and others, please read our weekly Earnings Trends reports.

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