3/30/2017 0 Comments
I have concerns over a disappointment in 1Q GDP growth. GDPNow stands at 0.9%, and its next update is Monday, April 3. Given the apparent lack of growth and the market's optimistic pricing of fiscal stimulus and tax cuts, I am inclined to be conservative from an investment perspective. I have been sniffing around for more defensive and yield oriented investments. What came onto my radar is the telecom sector. This is a countercyclical sector and the worst performing sector over the past year.
In addition to countercyclical sectors, I have been focused on sectors which have a relatively low correlation to the S&P 500 Index. Telecom does not have the lowest correlation, which goes to utilities then REITs, but it is lower than most other sectors. The utility sector has had a nice run up, and I might be more interested in utilities after a pullback. I do like the REIT sector, but this post will focus on telecom.
The telecom sector is relatively small at $1.9T market cap, and U.S. telecom is highly concentrated in $VZ and $T. Most of the other large telecom stocks are foreign businesses who issued depository receipts in the U.S. Given the high level of concentration and the low dividend yield of the telecom sector ETFs, I don't see an advantage to buying a sector ETF in this case. I would recommend buying either $VZ or $T directly to overweight the telecom sector. $VZ has not moved much in price for several years while $T has rallied from the low 30's to the low 40's. $VZ is also cheaper on a EV/EBITDA basis at 7.4x.
From a qualitative perspective, I don't view the 'cord-cutting' trend as disastrous to the telecom industry because customers still need to access the internet from either a cellular LTE or broadband service. Much of the weakness in telecom is a result of the 'cord-cutting' trend, and I view this secular shift as priced into the stocks at this point. Furthermore, I believe recent consolidation in the sector has lowered competitive pressures. More consolidation is also a possibility given the merger-friendly Trump administration.
$VZ has been financially levered at over 2x debt to EBITDA following the acquisition of Verizon Wireless in 2014, but the industry median leverage is higher, at over 3x. Although I don't regard telecom as an industry in the best financial health, it has stablity and significant barriers to entry.
Finally, I looked at the dividend yield. $VZ has a much higher yield than the utilities sector, 4.7% versus 3.0%. $VZ is paying out between 50% to 70% of earnings in dividends. I view this payout ratio as sustainable. 2016 was a pretty rough year for $VZ. Revenue was down 4% and eps over 20%. In 2017, revenue is expected to be flat to down a hair. Margin pressures are expected to ease leaving eps flat, good enough to easily maintain the dividend.
Since I am not feeling particularly bullish on the overall market in the short-term given the bleak 1Q GDP outlook, I am searching for stability and yield, not a supercharged growth stock. So $VZ fits the bill, and has some potential upside due to its low valuation and the friendly regulatory environment. I could see $VZ making new ATHs this year, a 16+% upside. That would bring $VZ's valuation in line with $T (8.6x) on a EV/EBITDA basis.
Michael Grove, CFA