3 Communication Stocks Likely to Brave Industry Headwinds
Amid this backdrop, Deutsche Telekom AG DTEGY, Shenandoah Telecommunications Company SHEN and VEON Ltd. VEON should benefit from higher demand for scalable infrastructure for seamless connectivity amid the wide proliferation of IoT and transition to cloud.
Industry Description
The Zacks Diversified Communication Services industry comprises firms that provide a wide array of communication services, including wireless, wireline and Internet, to business enterprises and consumers. These companies offer mobile and wireline telephone services, high-speed Internet, direct-to-home satellite television and other value-added services. In addition to providing integrated information and communications technology services to businesses and governments, some of these companies operate as local exchange carriers or full-service providers of data center colocation and related managed services in state-of-the-art data center facilities. Some industry participants also provide IP networks, private lines, network management and hosting services, along with sales, installation and maintenance of major branded IT and telephony equipment.
What's Shaping the Future of the Diversified Communication Services Industry?
Depleting Margins: Video and other bandwidth-intensive applications have witnessed exponential growth owing to the wide proliferation of smartphones and increased deployment of the superfast 5G technology. This has forced the industry participants to invest considerably in LTE, broadband and fiber to provide additional capacity and ramp up the Internet and wireless networks. 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 while attracting new customers. Although these infrastructure investments are likely to be beneficial, short-term profitability has largely been compromised.
Soaring Raw Material Prices: The industry continues to face a dearth of chips, which are the building blocks for various equipment used by telecom carriers. Moreover, high raw material prices due to the Iran war, shipping restrictions in the Strait of Hormuz, soaring energy prices, inflation and economic sanctions against the Putin regime have affected the operation schedules of several firms. Extended lead times for basic components are also likely to hurt the delivery schedule and escalate production costs. The demand-supply imbalance has crippled operations and largely affected profitability due to inflated equipment prices.
Customized Services: 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 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 stemming from volatility in demand, an unpredictable business environment and challenging geopolitical scenarios by offering free services to low-income families and seamless wireless connectivity.
Demand Erosion: Efforts to offset substantial capital expenditure for upgrading network infrastructure by raising fees have reduced demand, as customers tend to switch to lower-priced alternatives. Moreover, local-line access for traditional telephony services continues to decline among large customers due to higher wireless substitution and migration to IP-based services. This is reflected in the persistent erosion of overall network access services year over year, hurting revenues of local and long-distance operations. In addition, a shift toward wireless services and the aggressive rollout of VoIP and long-distance services by Tier-1 competitors have resulted in access line erosion. These adverse impacts have become more pronounced with the Middle East tensions and the prolonged Russia-Ukraine war.
Zacks Industry Rank Indicates Bearish Prospects
The Zacks Diversified Communication Services industry is housed within the broader Zacks Utilities sector. It carries a Zacks Industry Rank #203, which places it in the bottom 17% of more than 250 Zacks industries.
The group’s Zacks Industry Rank, which is 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 outperform the bottom 50% by a factor of more than 2 to 1.
Before we present a few diversified communication stocks that are well-positioned to outperform the market based on a relatively modest earnings outlook, let’s take a look at the industry’s recent stock market performance and valuation picture.
Industry Lags S&P 500, Sector
The Zacks Diversified Communication Services industry has lagged the S&P 500 composite and the broader Zacks Utilities sector over the past year due to macroeconomic headwinds.
The industry has declined 10.8% over this period against the S&P 500’s and the sector’s growth of 22.8% and 10.4%, respectively.
One-Year Price Performance
Industry's Current Valuation
On the basis of the trailing 12-month enterprise value-to-EBITDA (EV/EBITDA), which is the most appropriate multiple for valuing telecom stocks, the industry is currently trading at 8.16X compared with the S&P 500’s 18.09X. It is also trading below the sector’s trailing 12-month EV/EBITDA of 16.34X.
Over the past five years, the industry has traded as high as 10.5X, as low as 6.03X and at the median of 7.56X, as the chart below shows.
Trailing 12-Month enterprise value-to EBITDA (EV/EBITDA) Ratio
3 Diversified Communication Services Stocks to Buy
Deutsche Telekom: Headquartered in Bonn, Germany, Deutsche Telekom is one of the largest telecommunications service providers in Europe. In addition to its strong position in the domestic market, the company is poised to benefit from the accretive post-merger integration of T-Mobile US Inc. and Sprint in the United States, in which it owns about a 53% stake. The removal of forced cable TV access in multiple dwelling units in Germany through telecom legislation is likely to help the company expand its broadband market. Moreover, an aggressive fiber rollout strategy across the country is expected to augment its domestic market hold. It has a long-term earnings growth expectation of 17.2%. It has a VGM Score of A. Deutsche Telekom carries a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.
Price and Consensus: DTEGY
Shenandoah Telecommunications: Based in Edinburg, VA, Shenandoah Telecommunications provides various broadband communication services and cell tower colocation space in the Mid-Atlantic portion of the United States. It offers a high-speed, state-of-the-art fiber optic network, broadband Internet, video, voice, high-speed Ethernet, dark fiber leasing and managed network services. The company owns an extensive regional network with over 19,800 route miles of fiber. Shenandoah Telecommunications carries a Zacks Rank #2. It has a VGM Score of B.
Price and Consensus: SHEN
VEON: Headquartered in Amsterdam, the Netherlands, VEON offers voice, data and other telecommunication services through a range of wireless, fixed and broadband Internet services across Russia, Pakistan, Algeria, Uzbekistan, Ukraine, Bangladesh, Kazakhstan, Kyrgyzstan and Georgia. Continued investments in digital capabilities and services remain a key strategy for VEON as it aims to transform lifestyles through technology-driven services in some of the world's fastest-growing emerging markets. This Zacks Rank #2 company has a VGM Score of A.
Price and Consensus: VEON
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Deutsche Telekom AG (DTEGY): Free Stock Analysis Report
Shenandoah Telecommunications Co (SHEN): Free Stock Analysis Report
VEON Ltd. (VEON): Free Stock Analysis Report
This article originally published on Zacks Investment Research (zacks.com).
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