Telecom Services: 2 To Buy, 1 To Hold

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 |  Includes: T, TU, VZ
by: Winning Strategies

Economic uncertainty and increases in input costs are not significantly affecting the telecom services industry in 2013. Over the past few years there was prevailing concern in the industry about whether the slow economy and input cost inflation could hinder usage of mobile devices. However, that trend has proven to be wrong to some extent. Companies operating in this industry remained focused on growth and innovation, particularly vertical industries and the cloud. The expansion of technology and an array of data services provided incredible value to consumers, which in turn created value for all of the companies in the mobile ecosystem.

Companies are generating demand through technological innovation and by growth in business activity. The revenues and earnings of each company depend on efficient operations and good marketing activities. Large caps in this industry are enjoying big economies of scale in providing a highly automated service to a large number of customers, and they have the financial resources required to build and maintain large networks.

Companies operating in this industry offer wireline and wireless telephone and data services, Internet access, and cable and satellite television distribution services. Some of the major names this industry include U.S.-based AT&T (NYSE:T), Comcast (NASDAQ:CMCSA), and Verizon Communications (NYSE:VZ), as well as Canadian-based TELUS Corp. (NYSE:TU), Japan's Nippon Telegraph and Telephone Corporation (NYSE:NTT), and the Spanish firm Telefónica (NYSE:TEF).

In this article, I will look at the three best companies operating in this industry. Out of these three names, two are a safe haven for income investors while the other looks bit sluggish. The companies I'm looking at are TELUS Corp., AT&T, and Verizon.

How TELUS Corp. Is a Safe Investment

TELUS Corp. is a telecommunication company that provides telecommunications services and products including wireless, data, Internet protocol, voice, and television. Both its wireless and wireline segments continue to generate strong operating and financial results. Its business strategy to focus on investments in advanced broadband data technology and services is generating strong bottom-line growth.

TELUS has a long history of dividend raises and has the ability to do so for a long time. The company has potential to generate excessive cash flow. With the potential to generate strong cash flow and the ability to maintain a healthy balance sheet, it has returned $1.175 billion in dividends and share purchases in the first half. TELUS has shown strong price performance over the years, and currently offers an attractive entry point as the stock is trading at only 16x earnings, which is well below the 52-week high.

Its financial results show clearly convincing EBITDA growth of more than 6% in the second quarter. TELUS is successfully increasing its customer base. This is evidenced in its Q2 results that show 100,000 new postpaid wireless customers, 31,000 additional TV subscribers, and 13,000 more high-speed Internet customers.

TELUS is a company that has the ability to make capital investments in broadband technology. It has client services that support its future success, combined with returning significant cash to shareholders. Its strong cash-generating potential enables it to plan a share buyback of up to 2.5 billion until 2016.

How AT&T Is a Safe Investment

AT&T is the second company on this list, operating in the telecom industry. AT&T is famous for paying consistently increasing dividends. At present, it is paying a quarterly dividend of $0.45 per share, yielding 5.03%. In the past five years it has increased its dividend by 12% with steady price appreciation.

AT&T, including its subsidiaries and affiliates, provides wireless and wireline telecommunications services in the United States and internationally. AT&T has sustained its dividend payments when top- and bottom-line growth is slow. AT&T generated second-quarter revenues of $32.1 billion, up 1.6% from the year before.

In order to enhance revenues and earnings, it recently acquired Leap Wireless for around $1.2 billion in cash. This acquisition means an additional 5 million customers. It is expected that Leap could generate $2.8 billion in revenues, which could improve things for AT&T. On the other hand, it has potential to generate massive cash flows. In Q2, it reported strong operating cash flows of $9.5 billion. Its capital expenditure stands at $5.5 billion, mostly related to the deployment of its LTE network. The LTE deployment is projected to be complete in the summer of next year. Free cash flow in the recent quarter stands at $4.0 billion.

Its free cash flows are providing full coverage to its dividend payments as these dividend payments stand at $1.7 billion in the recent quarter. Its price-to-free cash flow ratio of 15.5 also demonstrates its cash-generating potential. AT&T looks like a safe pick with its recent acquisitions, smart capital investment, and strong cash flows.

How Verizon Is Not a Safe Investment

Verizon Communications is a provider of communications, information, and entertainment products and services to consumers, businesses, and governmental agencies. Its two segments are Verizon Wireless and wireline. Verizon is offering a quarterly dividend of $0.53/share with a payout ratio based on earnings of 284%. This means the company is paying more in dividends than its earnings. Its dividend payments are also going above its free cash flows as, in the trailing 12 months, its dividend payments are at 13.9 billion while free cash flows are at 12.8 billion and net income is at 12.4 billion.

Due to large dividend payments and massive capital investments, the company is also not working on any buybacks. This implies that the company has to pay dividends to around 2.9 billion shares of common stock outstanding. On the other hand, Verizon has to make investments in growth opportunities in order to enhance both its top and bottom lines.

Recently, Verizon reached an agreement to acquire Vodafone's 45% interest in Verizon Wireless for $130 billion. Verizon will pay $58 billion in cash and the reaming amount stock authorization and other items. To pay it off, the company has been taking on new debt of around $61 billion. This new debt and equity might not paint an encouraging picture for the company when its debt-to-equity ratio is already very high at 1.2.

With this deal, the company will have ownership of 100% of the wireless business, around 67% of operating revenues, and around 95% of free cash flows come from the wireless segment. Investors should wait to initiate a position until the company successfully turns things around. Verizon is not a good buy as it is struggling to grow its business and stabilize its financial situation.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.