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Communication Components Stock Outlook: Prospects a Mixed Bag

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The telecommunications industry is driven by a complex value chain that begins with various building blocks such as small cells, routers and antennas. These communication components are incorporated into equipment and facilities, and are subsequently utilized by service providers to build networks for end users. With massive proliferation of smartphones and exponential growth in data traffic, the prospects of the Communication Components industry appear quite enterprising and remains poised to benefit from favorable growth dynamics. 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.

Telecom service providers are increasingly leaning toward fiber optic cable in order to meet the burgeoning demand for cloud-based business data and video-streaming services by individuals. Moreover, fiber-optic cable network is vital for backhaul and last mile local loop, which are required by wireless service providers for their upcoming 5G network. Fiber networks are also essential for the growing deployment of small cells that bring the network closer to the user and supplement macro networks to provide extensive coverage. Higher utilization of advanced routers to deliver data packets from one network to another are gaining prominence, while state-of-the-art antenna systems remain essential architectural components for seamless connectivity.  

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 Comparison With S&P 500, Sector

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 Communication Components Industry within the broader Zacks Computer and Technology Sector has underperformed both its own sector as well as the benchmark S&P 500 Index over the past year.

While the stocks in this industry have collectively gained 8.8%, the Zacks S&P 500 Composite and Zacks Computer and Technology Sector have rallied 17.4% and 18%, respectively.

One-Year Price Performance


 

Sector Stocks Trading Cheap

Owing to the lackluster performance of the industry on average over the past year, the valuation looks a bit inexpensive. 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 10.1, which is near the median level over the past year. When compared with the highest level of 88.71 and median level of 9.86 over that period, there is apparently plenty of upside left.

The space looks inexpensive when compared with the market at large, as the trailing 12-month EV/EBITDA ratio for the S&P 500 is 11.92 and the median level is 11.5.

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 discount. The Zacks Computer and Technology Sector’s trailing 12-month EV/EBITDA ratio of 11.09 is above the Zacks Communication Infrastructure Industry’s ratio.

Enterprise Value/EBITDA Ratio (TTM)


Underperformance May Continue Due to Bleak Earnings Outlook

Expectations of deteriorating profit margins with intensive infrastructure investments for 5G push and trial testing 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 91 cents has declined 19.5% year over year as the trend in earnings estimate revisions reflected a continued downtrend.

Price and Consensus: Zacks Communication Components Industry
 

Looking at the aggregate earnings estimate revisions, it appears that analysts have mostly remained bearish about this group’s earnings potential.

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 a steady performance in the near term.

Currently, with a Zacks Industry Rank #62, the Zacks Communication Components industry is at the top 24% 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 Communication Components industry appears a tad unconvincing. Although the group’s mean estimate of long-term EPS growth rate has increased since June 2018 to reach the current level of 9.2%, 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 the group’s recurring earnings due to high operating costs and investments for 5G push.

 


 

Another important indication of declining long-term prospects is the downtrend in return on capital owing to higher infrastructure-related investments.


 

Bottom Line

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 relatively modest 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 communication components stocks that have a strong earnings outlook with cheap valuation metrics.

Below are four stocks within the communication components universe that have been witnessing positive earnings estimate revisions and carry either a Zacks Rank #1 (Strong Buy) or Zacks Rank 2 (Buy). You can see the complete list of today’s Zacks #1 Rank stocks here.

Turtle Beach Corporation (HEAR - Free Report) : Shares of this San Diego, CA-based communication components firm have gained a stellar 708% in the past year. The Zacks Consensus Estimate for the current-year EPS of has been revised 486.5% upward over the past 120 days. It currently sports a Zacks Rank #1.

Price and Consensus: HEAR
 

 

Corning Incorporated (GLW - Free Report) : The consensus EPS estimate for this Corning, NY-based communication components company has moved 3.6% higher for the current fiscal since February. This Zacks Rank #2 stock has gained 17.5% over the past year.

Price and Consensus: GLW
 

 

Plantronics, Inc. (PLT - Free Report) : Shares of this Santa Cruz, CA-based communication components firm have rallied 49.8% in the past year. This Zacks Rank #2 stock’s consensus EPS estimate for the current year has been revised 19.9% upward over the past 90 days.

Price and Consensus: PLT


 

Acacia Communications, Inc. (ACIA - Free Report) : Shares of this Maynard, MA-based communication components company have rallied 17.2% in the past three months. This Zacks Rank #2 stock’s consensus EPS estimate for the current year has been revised 116.7% upward over the past 60 days.

Price and Consensus: ACIA
 

 

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