Given macro uncertainty, investors naturally are shifting their portfolio investments to income stocks with low betas. The telecommunications sector, however, has shown its risks and consolidation will inevitably result in winners and losers - yielding greater risk than what the market acknowledges. CenturyLink (NYSE:CTL) is currently rated near a "strong buy" while Frontier Communications (NYSE:FTR) is rated near a "hold".
From a multiples perspective, CenturyLink is the cheaper of the two. It trades at a respective 20.8x and 14.2x past and forward earnings while Frontier trades at a respective 31.7x and 17.6x past and forward earnings. Both offer little 30% less volatility than the general market and pass on significant earnings through dividend yields.
At the third quarter earnings call, Frontier's CEO noted several favorable developments:
"System conversions significantly enhanced our ability to manage the business and further reduce costs. We now expect to convert the remaining 9 states by the end of the second quarter of 2012.
Our broadband expansion reached an additional 126,000 new homes in the acquired properties during the quarter, bringing our year-to-date total to 352,000 which is on track to reach our 2011 goal of increasing broadband availability to more than 400,000 additional homes. Broadband availability in the acquired properties is now 80%, a significant increase from the mid-60% range when we acquired them. As a result of our expansion and sales efforts, we had a very strong quarter for broadband growth, adding 16,900 total DSL subscribers, a 38% sequential increase from Q2. We also added 2,300 wireless data customers. This growth reflected the effectiveness of our local engagement model, as well as organic demand for broadband in both legacy and acquired properties".
The recent rejection of AT&T's (NYSE:T) multi-billion dollar bid for T-Mobile produced major implications on the entire sector. Some are even speculating over a Sprint (NYSE:S) and T-Mobile combination - a view arising from the belief that regulators will be able to swallow smaller deals. With the election date nearing, investors should expect to see greater volatility since it impacts the board of the FCC and DOJ. In addition, while unemployment has been declining, national income levels are down. In fact, real median income declined by 2.3% in 2010. The reduction in consumer expenditures will put pressure on greater merger activity from companies like Frontier.
Consensus estimates for Frontier's EPS forecast that it will decline by 50% to $0.24 in 2011 and then grow by 8.3% and 3.8% more in the following two years. Assuming a multiple of 20x and a conservative 2012 EPS of $0.23, the company is roughly trading at fair value. If the multiple were to decline to 18x and 2012 EPS turns out to be 2 cents less, the stock would plummet by 20.4%. This risk/reward is, accordingly, poor and warrants the "hold" rating.
CenturyLink, on the other hand, had strong third quarter results with progress in integrating acquisitions. Diluted adjusted EPS was at the high-end of consensus and positive momentum was seen in all segments. The Qwest acquisition will help the company penetrate the FFTN market and expand the customer base while Prism TV will contribute upwards of 1M additions. LEC, furthermore, has significant room for increases in scale.
Consensus estimates for CenturyLink's EPS forecast that it will decline by 21.2% to $2.67 in 2011, decline by 3.4% in 2012, and then grow by 1.2% in the following two years. Assuming a multiple of 18x and a conservative 2012 EPS of $2.54, the rough intrinsic value of the stock is $45.72, implying 23.8% upside. Even if the multiple were to decline to 11x and 2012 EPS turns out to be 3.5% below consensus, the stock would still rise by 7.8%.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.