At present, the telecom service sector has a soft outlook due to the slow pace and uncertain sustainability of the revenue recovery. Many analysts, including Moody, have maintained a negative outlook on this sector over the past year, and it is expected that telecom companies will need sustainable 1% to 3% annual revenue growth in order to stabilize. Meanwhile, prices in some of the most competitive markets will continue to drop as competitors fight to keep their market share positions.
Telecom companies are driving demand through technological innovation combined with growth in business activity. The top and bottom line growth for each company mainly depends on efficient operations, new inventions and strong marketing activities. Some of the large caps in telecom services are enjoying economies of scale in offering a highly automated service to mass customers, and they have the financial resources to maintain large networks.
Companies operating in telecom services offer wireline and wireless telephone and Internet access, data services, and cable and satellite television distribution services. Major players in this industry are U.S.-based AT&T (NYSE:T), Canadian-based TELUS Corp. (NYSE:TU), Comcast (NASDAQ:CMCSA), Verizon Communications (NYSE:VZ) and the Spanish firm Telefónica (NYSE:TEF). In this article, I look at the three large caps operating in this industry. Out of these three, two look like a safe haven for income investors while the other appears a bit sluggish. The companies I'm looking at here are TELUS Corp., AT&T, and Verizon.
How TELUS is an Attractive Investment
TELUS offers telecommunications services and products including data, wireless, Internet protocol, voice and television. With its strategic investments in advanced broadband technology and services, combined with its unwavering concentration on putting customers first and enhancing operational efficiencies, TELUS has generated increasing earnings over the years. In particular, its plan to focus on capital investments in advanced broadband data technology and services is gathering strong bottom-line growth.
TELUS continues to attract new clients as, in the third quarter, it has added 106,000 new postpaid wireless customers, 34,000 new TV clients, and 19,000 new high-speed Internet connections. This excellence in attracting new customers helped the company to generate record earnings per share of $0.56/share, an increase of 14%. Furthermore, its strong top and bottom line growth enables it to produce robust free cash flows. The potential to generate strong cash flows allows TELUS to further invest in growth opportunities combined with providing superior investment returns to shareholders.
It the past nine months, TELUS has generated $915 million in free cash flows, while dividend payments are at $639 million. As free cash flows are providing complete coverage to dividends, they look completely safe. Its payout ratio of 62% is also manageable. In the past five years, TELUS has increased its dividends by 86%. Up until 2016, the company is targeting semi-annual increases of .10/share and buyback of up to $2.5 billion. Its strong execution along with its balance sheet strength has placed this company in a unique position to effectively complete its unique, multi-year shareholder-friendly initiatives. Further, I believe its aggressive buyback is enhancing both earnings per share and future dividend increases.
How Verizon is an Attractive Investment
Verizon provides communications, information and entertainment products and services. Its two segments are Verizon Wireless and Wireline. Verizon has been turning things around by making smart moves to keep growing its top and bottom line. Recently, Verizon reported double-digit percentage growth in both operating income and earnings per share for the third successive quarter.
The company's unwavering focus on wireless, FiOS and strategic enterprise services has generated consistent performance and led to the delivery of double-digit earnings growth. Its Q3 results show high customer demand for Verizon Wireless, strategic enterprise services and FiOS. Verizon's long-term investments in reliable, high-quality networks are delivering value to customers and for the company as well. Indeed, its strategic networks are forming a strong distribution platform for future growth and innovation.
With extremely strong top and bottom line growth, Verizon's cash generating potential is also increasing. The company's recent agreement with Vodafone will further enhance its top and bottom line as well as cash generating potential. With this agreement, Verizon will have 100% ownership of the wireless business, just about 67% of operating revenues, and about 95% of free cash flows coming from the wireless segment.
In the past nine months, it has been able to grow operating cash flows by 14.7% and free cash flows by 23.3%. This massive increase in cash flows has negated any prevailing risks to its dividends as its free cash flows are now providing complete coverage to dividend payments. Also in the past nine months, the company has generated free cash flows of $16.6 billion, while dividend payments are at $14 billion. Its payout ratio comes in around 70%, which is a manageable level. With these striking results, massive growth in cash flows and smart investments, Verizon once again looks to be a safe company for dividend investors. Additionally, the company has been looking to grow its top line by 12% by the end of 2013, which is expected to further stabilize its position.
How AT&T is not an Attractive Investment
AT&T through its subsidiaries provides wireless and wireline telecommunications services in the United States and globally. AT&T recently reported Q3 results, with revenue and earnings growth driven mainly by mobile and IP data, strategic business services and U-verse.
On the positive side, the company is setting the standard for 4G LTE speeds and network reliability. Its fiber and U-verse expansion projects are ahead of schedule, bringing high-speed broadband to millions more customers. With these initiatives, the company seeks strong growth across its major platforms-including mobility, U-verse and strategic business services.
Despite these positive signs, AT&T's mild growth in top and bottom line hinders its cash generating potential. Its price to cash flow ratio of 7.2 also demonstrates this; still, its free cash flows are fully covering dividend payments. In Q3, cash from operating activities is at $9.2 billion, and capital expenditure is at $6.0 billion. Thus, free cash flows are at $3.2 billion. On the other hand, it's very high payout ratio, based on an income of 96%, does not allow it to make a huge increase in dividends. In other words, the company is paying around 96% of its income to investors in the form of dividends. That is the reason, in the past five years; its dividends are only up by 9% and why its price appreciation is not faring well either.
The company is taking strong initiative to boost both top and bottom line, including its recent acquisition of Leap Wireless for around $1.2 billion. It is expected that Leap could make $2.8 billion in revenues, which could perk up things for AT&T. Also, the company is working on a share repurchase program, which could provide support to EPS and dividends. Given the current financial situation and faced with tough competition in the market, the company has the ability to sustain its current dividend growth level, but I am not expecting big movement in dividends. At the moment, I strongly believe AT&T is not a good choice for dividend-growth investors while many other companies are offering far higher dividend growth with steady price appreciation.
Technological innovation will continue to prove essential in the telecom services industry, permitting companies to gain a competitive advantage. Likewise, lower top-line growth is expected to continue to mediate capital spending decisions. Companies operating in this industry are expected to remain focused on enhancing their balance sheet, free cash-flow generation and financial discipline. I believe TELUS is a safe haven for investors, while VZ is turning things around and enhancing its cash generating potential with its smart investment strategy. Finally, AT&T has the ability to sustain its current dividend growth level, but this is very low and, as a result, AT&T does not look to become an attractive dividend giant.
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.