The Capex Trend Is Your Friend

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 |  Includes: CHL, CHTR, CMCSA, FNSR, NOK, T, TEF, VOD, VZ
by: Nikos Theodosopoulos

A key fundamental driver of the communications equipment industry and associated supply chain stock performance is the growth in overall capital spending by service providers, including wireless, fixed and cable TV operators. Coming into 2014, the general expectation by Wall Street analysts was for it to be a decent year of overall growth in capital spending on the order of 2%-4%, with the wireless component growing much faster in the 6%-9% range. The 2014 growth expectation was due to a ramp in spending in key markets like China given the expectation that LTE would be finally rolled out in earnest, Europe given operators were expected to start growing spending after a period of under-investment in the past few years, and the US given wireless operators were expected to continue to grow spending to enhance network quality and expand LTE coverage.

After reviewing some of the key telecom operator 4Q13 results in these regions and their respective comments on capital spending plans for 2014, the general bias on 2014 capital spending by operators was generally to either maintain or raise capex expectations. In addition to expected capex spending growth in wireless I mentioned above, we also heard better spending plans in fixed networks in the US from the larger three cable TV operators and in Europe by traditional fixed operators. I continue to view the upward bias on 2014 operator capex as favorable for communications equipment and supply chain companies. While several companies may benefit from this trend, I am currently long Alcatel-Lucent (ALU) and Finisar (NASDAQ:FNSR) as stocks to play this theme. Both are beneficiaries of the upward bias on capital spending, while Alcatel-Lucent has the added benefit of a restructuring story. Finisar has the added benefits of relatively higher exposure to the optical upgrade in China and ramping deployments of "white box" switches by Web 2.0 companies (e.g., Amazon (NASDAQ:AMZN)) that utilize its optical sub-systems. Keep in mind, both ALU and FNSR are very volatile stocks and can have extreme negative reactions to any negative earnings or other negative fundamental news.

Here are some key highlights of recent capital spending commentary from key operators in the US, China and Europe from 4Q13 earnings calls that took place in January and February:

China - After a delayed tendering process by China Mobile (NYSE:CHL) in 2013 for LTE equipment suppliers, a portion of its capital spending was delayed into 2014. This deferral into 2014, combined with all the major operators ramping LTE spending in 2014 is likely to lead to an overall China capex growth of 15% in 2014 vs. prior expectations of about 10% growth.

US - In the US, AT&T (NYSE:T), Verizon (NYSE:VZ), T-Mobile (NASDAQ:TMUS), Comcast (NASDAQ:CMCSA), Time Warner Cable (TWC) and Charter (NASDAQ:CHTR) all raised their respective 2014 capex plans vs. prior analyst expectations. In addition, Google (NASDAQ:GOOG) announced it is planning to expand its Google Fiber network to 34 additional cities in the future, which may add to the competitive pressure in residential broadband networks in future years. Specific capex commentary from above mentioned US operators are as follows:

- AT&T: Announced Project Agile that will result in capex being about $21B in 2014 vs. prior estimates of about $20B

- Verizon: Guided 2014 capex to $16.5B-$17.0B vs. prior estimates of $16.0B-$16.5B.

- Time Warner Cable: Guided 2014 capex to $3.7B-$3.8B vs. prior estimates of about $3.2B-$3.3B given new initiatives such as all digital conversion.

- Comcast: Guided 2014 capex about $800M higher than 2013 given initiatives around digital set top boxes and Wi-Fi routers.

- Charter: Guided 2014 capex higher than expected by about $400M primarily due to all digital conversion resulting in 2014 capex of about $2.2B vs. prior estimates of about $1.8B.

Europe - In Europe, there continues to be early signs of a need for network operators to upgrade their networks after a period of cautious investment in the past few years. The two most notable examples were Vodafone (NASDAQ:VOD) and Telefonica (NYSE:TEF). Vodafone announced Project Spring in 4Q13 that will result in capex of about £7.3B in 2014 vs. £6.2B in 2013. Telefonica raised its expected capex/sales ratio for 2014 to 15.5-16% compared to 14.5% in 2013 to fund new network upgrade programs.

Disclosure: I am long ALU, FNSR. 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.

Additional disclosure: Any company mentioned in this article may have been a client in the past or may be a client in the future of consulting firm NT Advisors LLC.