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Diversified Communication Outlook Portrays Bearish Trends

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The Zacks Diversified Communication Services industry comprises firms that provide a gamut of communication services, including wireless, wireline and Internet (broadband, dial-up and entertainment) services, to businesses and consumers. These companies offer both 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 the companies operate as a 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 line, network management and hosting services along with the sale, installation, and maintenance of major branded IT and telephony equipment.

Here are the three major themes in the industry:

•    With rapid growth in video and other bandwidth-intensive applications due to increased 5G deployments, the industry participants are making considerable investments in LTE, broadband and fiber to provide additional capacity and ramp up Internet and wireless networks. As a result, 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 and attract new customers. Increasing demand for reliable access and fast-data services is expected to expand customer base.

•    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 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 local and long-distance operations. With Digital Subscriber Line (DSL) 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, the shift toward wireless services and aggressive rollout of VoIP and long-distance services by Tier-1 competitors have further contributed to access line erosion.

•    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 braving 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 #235, which places it at the bottom 8% 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 fiscal and the next fiscal have declined 8.3% and 10.7%, respectively.

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 rallied 2.5% over this period compared with the S&P 500’s rise of 5.6% and broader sector’s gain of 10.7%.

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 7.71X compared to the S&P 500’s 11.19X. It is also below the sector’s trailing-12-month EV/EBITDA of 13.27X.

Over the past five years, the industry has traded as high as 12.74X, as low as 7.23X and at the median of 9.81X, 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 is likely to face operational headwinds in the near term.

Two stocks in the space currently carry a Zacks Rank #2 (Buy), while none sports a Zacks Rank #1 (Strong Buy). You can see the complete list of today’s Zacks #1 Rank stocks here. We are also presenting two stocks with Zacks Rank #3 (Hold) that investors may currently hold on to.

Swisscom AG (SCMWY - Free Report) : Headquartered in Bern, Switzerland, this diversified communication services provider has gained 9.7% in the past year. The Zacks Consensus Estimate for current-fiscal earnings of this Zacks Rank #2 stock has increased 5.3% over the past 90 days.

Price and Consensus: SCMWY

TELUS Corporation (TU - Free Report) : Based in Vancouver, Canada, this diversified communication services provider has gained 12.4% year to date. The stock has long-term earnings growth expectation of 8%. TELUS currently carries a Zacks Rank #2.

Price and Consensus: TU

Telstra Corporation Limited (TLSYY - Free Report) : Based in Melbourne, Australia, this diversified communication services provider has gained 29.2% in the past year. The Zacks Consensus Estimate for current-fiscal and next-fiscal earnings of this Zacks Rank #3 stock has increased 3.9% and 4.8%, respectively, over the past year.

Price and Consensus: TLSYY

VEON Ltd. (VEON - Free Report) : Headquartered in Amsterdam, the Netherlands, this diversified communication services provider has gained 32.5% year to date. The Zacks Consensus Estimate for current-fiscal and next-fiscal earnings of this Zacks Rank #3 stock has increased 85.7% and 60.7%, respectively, over the past year.

Price and Consensus: VEON

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