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Diversified Communication Industry Outlook: Prospects Look Bleak

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The Zacks Diversified Communication Services Industry consists of companies that provide a gamut of communication services including wireless, wireline and Internet communications for voice and data to businesses and consumers. These companies offer both mobile and wireline telephone services along with high-speed Internet, direct-to-home satellite television and Voice over Internet Protocol services. In addition to offering integrated information and communications technology services to businesses and governments, some of the companies operate as a full-service provider of data center colocation and related managed services in state-of-the-art data center facilities.

Here are the three major themes in the industry:

•    With rapid growth in video and other bandwidth-intensive applications, the industry participants are making considerable investments in LTE, broadband and fiber in order to provide additional capacity and ramp up Internet and wireless networks. As a result, these companies are rapidly transforming 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 and attract new customers. Increasing demand for reliable access and fast-data services are expected to expand customer base.  

•    The efforts to offset substantial capital expenditure for upgrading the network infrastructure by raising fees could reduce demand, as customers tend to switch to lower-priced carriers. 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 the local and long-distance operations.

•    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 the 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 by offering a wide array of services at competitive rates and anticipates an uptick in demand for its virtual data center and staff augmentation services.

Overall, the industry appears to be mired in short-term headwinds with significant capital expenditures and price wars eroding margins.

Zacks Industry Rank Indicates Gloomy Prospects

The Zacks Diversified Communication Services Industry is housed within the broader Zacks Utilities sector. It carries a Zacks Industry Rank #209, which places it at the bottom 18% 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 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 year have declined 8.3%.

Before we present a few diversified communication stocks that are well positioned to outperform the market based on a strong 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 as well as the S&P 500 Index over the past year.

The industry has declined 18.3% over this period compared to the S&P 500’s rise of 6.2% and broader sector’s fall of 6.2%.

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 9.05X compared to the S&P 500’s 11.33X. It is also below the sector’s trailing-12-month EV/EBITDA of 12.55X.

Over the past five years, the industry has traded as high as 11.33X, as low as 7.36X and at the median of 9.26X, as the chart below shows.

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

Bottom Line

The industry should gradually recover once the market stabilizes and the effect of the capital investments percolates. However, it will continue to face near-term operational headwinds.

None of the stocks in the space currently sport a Zacks Rank #1 (Strong Buy). You can see the complete list of today’s Zacks #1 Rank stocks here. However, we are presenting two stocks with a Zacks Rank #2 (Buy) that are well positioned to grow amid challenges. There is another stock with Zacks Rank #3 (Hold) that investors may currently hold on to.

Deutsche Telekom AG (DTEGY - Free Report) : Headquartered in Bonn, Germany, this integrated telecommunication services provider has gained 0.2% in the past 30 days. The Zacks Consensus Estimate for current-fiscal earnings of this Zacks Rank #2 stock has remained relatively stable over the past 90 days.

Price and Consensus: DTEGY

Swisscom AG (SCMWY - Free Report) : Headquartered in Worblaufen, Switzerland, this diversified communications service provider has long-term earnings growth expectations of 1.4%. The Zacks Consensus Estimate for current-fiscal earnings of this Zacks Rank #2 stock has moved up 2.5% over the past 90 days to $2.91.

Price and Consensus: SCMWY

TELUS Corporation (TU - Free Report) : Based in Vancouver, Canada, this diversified telecommunications services firm has long-term earnings growth expectations of 8%. The Zacks Consensus Estimate for current-fiscal earnings of this Zacks Rank #3 stock has remained relatively stable over the past 90 days.

Price and Consensus: TU

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