He points particularly to the dividend-paying wireline companies for their defensive strength and stability. Among the S&P buys in that group are Verizon Communications (VZ
), Canadian phone company BCE (BCE
), and Alltel (AT
Alltel is an example of rural carriers that Rosenbluth likes -- others include CenturyTel (CTL
) and Citizens Communications (CZN
) -- partly because they "have fewer players in their backyard." And CenturyTel stands out by having moved against cable competition via a partnership with EchoStar Communications (DISH
) to offer satellite-TV service to its phone customers.
These were some of the points Rosenbluth made in an investing chat presented Aug. 31 by BusinessWeek Online and Standard & Poor's on America Online, in response to questions from the audience and from BW Online's Jack Dierdorff. Edited excerpts follow. A full transcript is available from BusinessWeek Online on AOL at keyword: BW Talk.
Note: Todd Rosenbluth is a Standard & Poor's Equity Analyst. He has no ownership interest in or affiliation with any of the companies under discussion in this chat. All of the views expressed in this chat accurately reflect the analyst's personal views regarding any and all of the subject securities or issuers. No part of the analyst's compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed in this chat. For required disclosure information and price charts for all S&P STARS-ranked companies go to spsecurities.com and click on "Investment Research," and then click on "Required Disclosures & Standard & Poor's STARS vs. Closing Prices Charts."
Q: Todd, what's the latest on the scene in telecom? Are stocks doing better?
A: Well, Jack, the S&P telecom-services sector is up more than 6% year-to-date though Aug. 27, outperforming the fractional decline in both the S&P 500 and 1500 indexes. However, in the last 13 weeks, the integrated or wireline telecom services stocks have really shined brightly. This subindustry is up 7.9% in the last 13 weeks, outperforming the broader market indexes, which declined 1.2%.
Q: BellSouth (BLS
) -- sell or hold?
A: We have an avoid recommendation on BellSouth shares. We expect the company's planned acquisition of AT&T Wireless (AWE
) through BellSouth's Cingular joint venture to be dilutive for the next few years. We see earnings for BellSouth declining from a likely $1.93 in 2004 to $1.45 in 2005. We think there are better areas within telecom to put your money.
Q: You said integrated and wireline companies have done well -- what about wireless?
A: Wireless stocks are up nearly 28% year-to-date through Aug. 27, but within the last 13 weeks they have underperformed their wireline peers, rising only 2%, vs. the 8% climb for wireline stocks. Due to a planned acquisition of AT&T Wireless and the recent recombination of Sprint's wireline and wireless tracking stocks, many of the wireless services stocks that we cover...are of the smaller-cap variety.
Q: What explains the underperformance by wireless? Just the AWE deal?
A: These wireless-services stocks have still outperformed the broader market, but the wireline stocks -- in particular the dividend-paying wireline stocks -- have performed strongly in recent months as their stability and defensive characteristics have, appropriately in our view, come into vogue. Among the buy recommendations that S&P has in the telecom space are high-yielders such as Verizon Communications (VZ
); BCE (BCE
), which is a Canadian phone company; and Alltel (AT
Q: Can you amplify on Verizon's strengths?
A: Happy to. We believe VZ has the best earnings prospects of the regional Bell companies, given its wireless strength and its expense control. Verizon's wireless offering has continued to take market share, even in a crowded operating arena. And the company has wider EBITDA [earnings before interest, taxes, depreciation, and amortization] margins than its peers. We also view Verizon's nearly 4% dividend yield as a positive for the stock.
Q: The Federal Communications Commission has just come out with new rules on local-service competition. Can you explain? And tell us what stocks will benefit?
A: Sure. As expected, last week the FCC released short-term rules freezing the wholesale access rates the regional Bell companies charge competitors for six months. With the absence of new rules, these wholesale rates will rise 15% for existing customers and even higher for new customers. We view this FCC ruling as positive for regional Bells like Verizon, but we still see challenges for the Bells from cable and wireless concerns.
Q: How big a challenge is voice over Internet (VoIP -- voice over Internet protocol)?
A: We expect VoIP offerings from cable providers to put a sizable amount of pressure on telecom companies in late 2004 and primarily in 2005. While we expect customer migration from the Bell companies to occur, a larger impact may be the resulting pricing pressure. Companies such as AT&T (T
), which offers a VoIP product, are charging as low as $19.95, which is well below what Baby Bell SBC Communications (SBC
) is offering for traditional wireline service.
Q: What about the former Bell companies you haven't mentioned?
A: We have avoid recommendations on SBC Communications and BellSouth due to competitive pressures and expected challenges related to their joint venture's acquisition of AT&T Wireless. Although these two stocks offer a dividend yield, we view their prospects as challenging. The other former Baby Bell, Qwest Communications (Q
), we have a hold recommendation on.
Q: What do you think about Qualcomm (QCOM
A: My colleague at S&P has a buy recommendation on QCOM shares. We see Qualcomm benefiting from significant sales growth and view favorably the company's nearly $7 billion in cash and no debt. QCOM is priced near its peers but is growing faster.
Q: Do you have any thoughts on suppliers to the telecom industry?
A: As I mentioned, we have a buy recommendation on Qualcomm, which my colleague covers. In addition, S&P has buy recommendations on Motorola (MOT
), Avaya (AV
), and TelLabs (TLAB
). Let me highlight Avaya in particular, as the company's core target market, Internet protocol telephony, continues to gain traction. Avaya shares are trading below its peers on p-e, p-e/growth, and price/sales metrics.Q: How about Nokia (NOK
A: We have an accumulate recommendation on Nokia. The company, in our view, retained cost leadership, while its R&D investments in software are prudent. Based on a multifactor valuation model, including some of the parts and relative multiples, we have a target price of $13.
Q: Has there been any erosion in wireline long-distance revenues because of e-mail and wireless deals? A sort of cultural change.
A: Yes. AT&T and Sprint (FON
) -- the latter of which we have an avoid recommendation on -- have faced challenges from both wireless substitution and e-mail usage. With all-you-can-eat local and long-distance wireless offerings, these long-distance carriers are under pressure from both a revenue and an earnings perspective.
Q: Where does this leave AT&T, especially without its wireless arm?
A: We have a hold recommendation on AT&T shares. We expect the company's operating margins to be constricted by revenue declines that we mentioned, as well as higher access costs and additional staff reductions. However, we would hold AT&T shares based on a dividend we view as stable and on a discounted valuation to peers. Our 12-month target price on AT&T is $16.
Q: What's your outlook on Lucent (LU
A: We have a hold recommendation on Lucent shares. We project September quarter gross margin at 43% on cost controls. Our operating earnings estimates are 14 cents in fiscal year 2004 and 18 cents in fiscal year '05. The fiscal years end in September.
Q: Do you track any telecom operations outside the U.S., such as Telefonos de Mexico (TMX
) or Deutsche Telekom (DT
A: We have a hold recommendation on Telefonos de Mexico. The company has a 4% dividend yield, and our 12-month target price is $34. North of the border, we follow Canadian telecom BCE. We have a buy recommendation on BCE shares. The company, in our view, has a stronger operational and regulatory arena than its U.S. peers, which has helped the company keep its customer base relatively steady. We have a 12-month target price on BCE of $24 and believe the company generates sufficient free cash flow to support its dividend yield.
Q: On the regulatory front, what should we be watching for? Or are things on hold till after the election?
A: We expect the FCC will provide some clarity on how Internet telephony is classified. Presently, this relatively new technology is classified differently than traditional telecom services, and thus its providers have a less stringent cost structure. We also expect the FCC to be working aggressively to formalize wholesale competition rules, as the rules recently announced are of an interim nature. However, we're skeptical that permanent rules can be agreed on, given the uncertain tenure of the commissioners as the election nears.
Q: Do you see any significant developments coming in telephone technology?
A: Yes, we do. Verizon is one of the carriers that has been testing and rolling out a fiber-to-the-premise (FTTP) service that will over the longer term add to the data services the company offers its customers. While this technology is in its early stages, Verizon has committed to providing it to 1 million homes by the end of 2004 and ramping it up in 2005.
Q: You like some rural carriers -- what makes them attractive?
A: Unlike the regional Bell companies that face sizable competition from wireless, cable, and currently wholesale wireline providers, the rural telcos like Alltel, CenturyTel (CTL
), and Citizens Communications (CZN
) have fewer players in their backyard. These rural carriers have exhibited greater customer stability over the past 12 months, and we think they're taking appropriate steps to combat pending competition.
For example, CenturyTel recently agreed to partner with EchoStar Communications (DISH
) to provide satellite-TV services to CenturyTel wireline customers. Unlike the regional Bells, we view positively CenturyTel's offensive technique against looming cable competition. Based on our relative analysis, CenturyTel shares appear undervalued to us.
Q: Do you expect telecom stocks to continue performing relatively better into the future?
A: Yes. S&P has an overweight recommendation on the telecom-services group. We believe that the dividends and cash-flow generating ability stand out in a broader market that has become defensive.
However, as has been discussed throughout this chat, we find some stocks to be more attractive than others. We have many buy recommendations that were mentioned, as well as avoids on SBC, BellSouth, and Sprint, to name a few. We also have a sell recommendation on Western Wireless (WWCA
) shares. We see WWCA's domestic wireless unit growing slower than peers and have a 12-month target price of $22.