Telecoms: Two Buys and Two Sells

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Includes: CHU, T, TMUS, VZ
by: Benjamin Goldman

I have recently analyzed 14 top telecommunications stocks, nine of which cover almost all of the American cell phone market and five which have large market caps from business outside of the United States. I will first start with a brief analysis of two stocks that I recommend buying and two I recommend selling, followed by a more in-depth analysis of my study.

Buys:

Verizon Communications (NYSE:VZ) holds a 55 percent share in the U.S. with Verizon Wireless Service (Vodafone (NASDAQ:VOD) owns the rest). The service is currently the largest in the country and has 101.5 million subscribers. Verizon boasted a 58.6% gross profit margin in 2010, which was much higher than top competitors AT&T (NYSE:T) (49.1%) and Sprint Nextel (NYSE:S) (46.3%). VZ is currently trading 4.27% lower than its 50-day moving average and 4.62% lower than its 200-day moving average, which sadly outperforms the S&P 500. In addition, Vodafone shares are trading 2.52% above their 50-day average, with a very similar value portfolio since they both own a large share of Verizon service. The European telecom market has been slightly outperforming the American market over the last nine months, but not by a spread of almost 7 percent.

Leap Wireless (LEAP) shares have suffered a rough past couple of months with its shares trading 56 percent and 55 percent lower than its 50- and 200-day moving averages, respectively. However, they show promise in the future. LEAP owns the growing Cricket Wireless network, with almost 6 million subscribers. Its low market cap of $523 million makes it an excellent acquisition target for several of the larger players in the American market that hope to replace struggling Sprint Nextel as the number three wireless provider. Its top line numbers compete with the rest of the American market with a 2010 gross margin of 46.9 percent, but profitability has been hurt by operating expenses that could be virtually eliminated by an acquisition. With about $2.8 billion in debt, an acquirer can pick up 6 million subscribers for about $3.4 billion of debt and equity, which would be a great value for any of the larger networks.

Sells:

MetroPCS Communications (PCS) shares dropped over 40 percent this past week from missed earnings and a negative earnings outlook, but their P/E ratio is still above the market average at 14.8 and many investors have developed a bearish outlook on MetroPCS. In 2010, its gross profit margin was 43%, which was the second lowest to only T-Mobile’s owner, Deutsche Telekom (OTCQX:DTEGF). Metro PCS is sixth in U.S. subscribers with 8.16 million, and will be fifth if or when the AT&T/T-Mobile merger closes. Its only chance at ever becoming a major player in the US market is if it acquires a smaller company to increase its subscriber base, which could come at a hefty premium when other competition gets involved. An acquisition will further drive down the value of its stock for the short term, but if it does not grow or make a powerful strategic move soon, investors may kick it to the curb entirely.

China Unicom (NYSE:CHU) is a wireless provider based in Beijing that serves mainland China. When comparing its stock to other telecommunications firms, it has by far the highest P/E ratio at 101.7. This is due in large part to decreased earnings over the last few years, which analysts expect to shoot up to $0.77 per share by the end of FY 2012 through increased revenue and lowered operating expenses. Although this is probable, China Unicom is trading at 3.75% above its 200-day moving average and may be overvalued at this point. Mainland China is a huge growth market, but one has to worry about bureaucracy and increasing salary demands by Chinese workers cutting away from earnings.

Analysis

Current Share Prices Compared to Moving Averages

Relative to:

50 day avg

200 day avg

US Firms

-5.14%

-3.76%

International Only

0.82%

0.63%

Both US and Intl

1.90%

-0.16%

Click to enlarge

To arrive at these recommendations, I reviewed 14 stocks with a very fundamental approach. I looked a lot at the profit margin of each company. Telecommunication companies gain value with more subscribers, so for long term growth, top line numbers are relatively more important because increased revenue and subscriber bases will quickly diminish operating costs. I looked over how each share is valued compared to its 50-day and 200-day moving averages to see how they have been performing compared to the other firms. I have provided a chart showing the weighted averages of each company type's performance. I also took a look at how their EBITDAs compares to their sizes. A telecom firm’s market cap and EBITDA has a correlation of 0.74 in the stocks I studied, and 0.81 in the American based firms. I made by Buy and Sell recommendations based on a combination of each firm’s core business strategy, gross profit margin, and EBITDA as it relates to market cap.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.