Dividend Paying Telecoms Stocks Buck Market Slump

2019 OUTLOOK: Telco stocks were among the few bright spots for 2018 returns - and continue to offer income and growth in the New Year

Michael Hodel 2 January, 2019 | 12:32PM
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Vodafone undervalued equity stocks UK telecoms

Telecom stocks across the globe have held up well amid the market’s recent turbulence, with the Morningstar Global Communication Services Index down only 5% in the fourth quarter versus a 14% drop for the broader market. We continue to believe that Europe offers a particularly attractive hunting ground for value, with our telecom coverage there trading at a 24% discount to our fair value estimates.

Telecom stocks in the US look more reasonably priced, trading at a 15% discount, but opportunities still exist. We suspect investors remain negative on European telecom stocks for a variety of reasons, including limited revenue growth potential, often complex operating structures, and, in many cases, exposure to emerging markets, where weak currencies have created messy financial results in recent quarters.

Also, many European telecom companies carry relatively heavy debt loads, while investments in fibre-optic networks and new wireless technologies have pressured free cash flow, producing fears of dividend cuts. To top it off, Brexit and European Union telecom regulation produce additional uncertainty. We believe that investors who wade through these complexities will be nicely rewarded.

We expect capital spending needs to moderate in developed markets as fibre buildouts near completion and an increasing portion of wireless technology becomes software-based. Increased demand for data capacity should favour those firms that invested appropriately in the networks, driving revenue growth and margin expansion in future years.

In short, we believe dividend pay-outs at most firms we cover are sustainable, providing generous returns as investors wait for telecom fortunes to turn around. In the US, the proposed merger of T-Mobile and Sprint remains the most important near-term development.

The wireless industry exhibits several elements of the efficient scale economic moat source, but the US wireless business hasn’t benefited from efficient scale recently because of the competitive imbalance in the industry.

T-Mobile and Sprint have had little choice but to price services aggressively to close the scale gap with AT&T and Verizon. A merged Sprint/T-Mobile would drastically improve the long-term structure of the US wireless industry, at least for carriers, in our view.

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Telefonica (TEF) is leading the European communications market into converged services. Additionally, it is laying extensive amounts of fiber to better compete with cable operators in providing fixed broadband services. It acquired E-Plus in Germany and GVT in Brazil, which strengthens its position in both countries and provides lots of opportunities for cost savings. We don't believe the market appreciates how well the firm is positioned or its margin expansion opportunities, which has caused

Vodafone (VOD) is one of the largest wireless carriers in the world. While the firm has had issues in some countries, such as India and Italy, it is increasing revenue in local-currency terms in most markets. The company has been focused on moving from a wireless-only provider to a converged operator.

In Europe, fixed-line telecom services now account for about 30% of revenue. On the wireless side, Vodafone continues to transition customers to smartphones and 4G technology, both of which generally lead to higher data usage and higher revenue. The stock yields more than 7%, and we believe the dividend is safe.

With the bidding wars surrounding Fox and Sky resolved, a major source of uncertainty has lifted. While we were disappointed that Comcast (CMCSA) was willing to pay a high price to win Sky, we believe management still showed discipline in walking away from Fox. We believe that the firm is very well-positioned competitively thanks to the strength of its core cable networks and the solid media franchises it possesses. We expect these strengths will serve Comcast well even as the television business continues to evolve.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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Securities Mentioned in Article

Security NamePriceChange (%)Morningstar
Comcast Corp Class A51.68 USD0.78Rating
Telefonica SA4.03 EUR0.00Rating
Vodafone Group PLC118.62 GBX0.29Rating

About Author

Michael Hodel