The Wireless Equipment industry remains poised to benefit from favorable growth dynamics as leading carriers plan to introduce 5G technology in select cities across the country by the end of 2018. In addition, macroeconomic tailwinds buoyed by President Trump's pro-growth policy changes, namely, significant cut in corporate tax and deregulation are likely to spur overall industry growth.
5G is billed as the technology of the future with faster download speed and seamless transfer of data. Leveraging state-of-the-art communication network architectures, 5G is touted to be the primary catalyst for next-generation Internet of Things (IoT) services. These include connected cars coupled with augmented reality and virtual reality platform, smart cities and connected devices that revolutionize key industry verticals. Moreover, 5G technology is likely to augment the scalability, security and universal mobility of the telecommunications industry, which is expected to propel the wide proliferation of IoT. With emergence of smart cities, connected vehicles and connected homes, 2018 promises to be a significant year for telecom carriers.
Furthermore, reduction in corporate tax rate from 35% to 20% has mostly been accretive to cash flow and has resulted in a huge windfall for telecom operators. The carriers have largely utilized this money for 5G network R&D and its deployment. Moreover, 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) has significantly benefited telecom carriers.
Industry Lags on Shareholder Returns
Looking at shareholder returns over the past year, it appears that a solid 5G push amid healthy economic fundamentals wasn’t enough for enhancing investors’ confidence in the industry’s prospects. In addition, geopolitical tensions and consequent fallouts on grounds of national security might have hurt the stability of the market and put the sector in a spot of bother.
The Zacks Wireless Equipment Industry within the broader Zacks Computer and Technology Sector has underperformed its own sector over the past year, although it outperformed the benchmark S&P 500 Index.
While the stocks in this industry have collectively gained 18%, the Zacks S&P 500 Composite and Zacks Computer and Technology Sector have rallied 17.6% and 20.6%, respectively.
One-Year Price Performance
Sector Stocks Trading at a Premium
Despite a highly volatile geopolitical scenario and mixed performance of the industry on average over the past year, the valuation looks a bit expensive. One might get a good sense of the industry’s relative valuation by looking at its enterprise value-to EBITDA ratio (EV/EBITDA), which is the most appropriate multiple for valuing telecom stocks.
Telecom is a capital-intensive industry with high fixed costs, bulk of which is funded through debt. Moreover, the companies have high depreciation expenses due to a large fixed asset base. The EV/EBITDA ratio essentially measures the value of a telecom company, inclusive of debt and other liabilities, to the actual cash earnings exclusive of the non-cash expenses.
The industry currently has a trailing 12-month EV/EBITDA ratio of 14.59, which is near the median level over the past year. When compared with the highest level of 20.21 and median level of 14.18 over that period, there is apparently plenty of upside left.
The space looks expensive when compared with the market at large, as the trailing 12-month EV/EBITDA ratio for the S&P 500 is 11.19 and the median level is 11.38.
Enterprise Value/EBITDA Ratio (TTM)
Comparing the group’s EV/EBITDA ratio with that of its broader sector also shows that the group is trading at a premium. The Zacks Computer and Technology Sector’s trailing 12-month EV/EBITDA ratio of 11 is well below the Zacks Communication Infrastructure Industry’s ratio.
Enterprise Value/EBITDA Ratio (TTM)
Outperformance May Continue on Solid Earnings Outlook
Expectations of healthy profit margins with intensive infrastructure investments for 5G push and favorable trial testing results will likely lead telecom infrastructure stocks to generate modest shareholder returns in the near future.
But what really matters to investors is whether this group has the potential to perform better than the broader market in the quarters ahead. One reliable measure that can help investors understand the industry’s prospects for a solid price performance is the earnings outlook for its member companies. Empirical research shows that a company’s earnings outlook significantly influences the performance of its stock.
One could get a good sense of a company’s earnings outlook by comparing the consensus earnings expectation for the current financial year with last year’s reported number. A more effective measure could be the magnitude and direction of the recent change in earnings estimates.
The consensus estimate for the Zacks Wireless Equipment Industry of 81 cents has marginally declined year over year as the trend in earnings estimate revisions reflected an almost flat trajectory.
Price and Consensus: Zacks Wireless Equipment Industry
Looking at the aggregate earnings estimate revisions, it appears that analysts have mostly remained positive about this group’s earnings potential although estimates have decreased slightly year over year.
Current Fiscal Year EPS Estimate Revisions
Zacks Industry Rank Indicates Healthy Prospects
The group’s Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates continued outperformance in the near term.
Currently, with a Zacks Industry Rank #34, the Zacks Wireless Equipment industry is at the top 13% of more than 250 Zacks industries. 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.
Industry Portrays Tempered Long-Term Growth
While the near-term prospects look fairly stable for investors, the long-term (3-5 years) EPS growth estimates for the Zacks Wireless Equipment industry appears a tad unconvincing. Although the group’s mean estimate of long-term EPS growth rate has remained fairly stable since March 2018 to reach the current level of 8.4%, it compares unfavorably with 9.8% for the Zacks S&P 500 Composite.
Mean Estimate of Long-Term EPS Growth Rate
In fact, the basis of a chequered long-term EPS growth could be deterioration in revenues that telecom firms have been showing since the beginning of 2012.
Another important indication of declining long-term prospects is the downtrend in the group’s recurring earnings due to high operating costs and investments for 5G push.
While the sector has evolved from predominantly a provider of voice services into a diverse, competitive and interconnected industry using terrestrial, satellite and wireless transmission systems, high operating costs and significant investments that contract margins remain potent challenges. Furthermore, a highly volatile geopolitical scenario has put pressure on the stability of the business and adversely affected the operating model.
Although there remain certain impediments to long-term growth, the industry looks poised to benefit in the near term on solid growth dynamics. So, it might be a good idea to bet on this space right now. Investors could be better off if they select a few wireless equipment stocks that have a strong earnings outlook despite premium valuation metrics.
Below are three stocks within the wireless equipment universe that have been witnessing positive earnings estimate revisions and carry either a Zacks Rank #1 (Strong Buy) of Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank stocks here.
Ribbon Communications Inc. (RBBN - Free Report) : The consensus EPS estimate for this Westford, MA-based wireless equipment company has moved 23.1% higher for the current fiscal year, in the last 90 days. This Zacks Rank #1 stock has gained 22.3% over the past three months.
Price and Consensus: RBBN
Clearfield, Inc. (CLFD - Free Report) : Shares of this Brooklyn Park, MN-based wireless equipment company have rallied 20.1% in the past year. This Zacks Rank #2 stock’s consensus EPS estimate for the current year has been revised 16% upward over the last 90 days.
Price and Consensus: CLFD
Qualcomm Incorporated (QCOM - Free Report) : Shares of this San Diego, CA-based wireless equipment company have rallied 23.5% in the past year. This Zacks Rank #2 stock’s consensus EPS estimate for the current year has been revised 31.8% upward over the last 90 days.
Price and Consensus: QCOM
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