It's time for a Sprint (NYSE:S) update.
For those who don't feel like using the search function on "The Ticker," I turned from very bearish on the name (in late 2011, when I thought the firm was headed to bankruptcy and a 100% loss for shareholders) to bullish in May of this year.
On May 2, the stock was about $2.50/share. This morning it stood at $5.65, better than a clean double. The reasons are fairly simple -- the firm has been executing. It not only used the ultra-low rate environment to refinance debt issues that threatened to sink the company, but also put high-end phones on its prepaid services, held the line with the only unlimited data plans in the marketplace, and surprised everyone with retention rates that nobody expected while shutting down its money pit (and horrifyingly mistaken) Nextel acquisition.
Simply put, companies don't go bankrupt when they have positive free cash flow, including debt service costs, and Sprint has turned the corner in that regard. While "all in" profits are probably a few quarters away at this point, on the trajectory the firm is traveling they will come.
The key question now is: "Where does the stock go from here?"
Let's put forward a scenario that assumes the firm continues to execute -- that its LTE rollout continues apace, that it spends once -- having wisely chosen to wait until it could get LTE-Advanced-compatible equipment, instead of having to buy twice as its competition is now being forced to do -- that it manages to hold its Nextel-related churn to reasonable levels, and that its customer satisfaction remains within rational boundaries and thus its customer base is retained and continues to grow. Provided the company can do these things and effectively capitalize on the good decisions made thus far in the turnaround, we must then look to metrics to see where they should end up.
Today, Sprint has no dividend and sells for 0.49 times sales and 1.84 times book. Itsgross profit margin runs some 30%, which would normally have you cheering, but unfortunately the hardware spend along with other operating costs bring EBIDTA to about one-third of that and leave net (those nasty "I" and "A" lines are big subtraction elements) negative.
Verizon (NYSE:VZ), for its part, has a price/sales of 1.15 and price/book of 3.5, roughly double Sprint's. Its EBIDTA is roughly one-half of its gross, which is surprisingly not that much better than Sprint's. However, it has a positive EPS largely due to its much lower debt load as compared to enterprise value. And, of course, it pays a dividend.
AT&T (NYSE:T), likewise, has an EBIDTA-to-gross ratio that is similar to Verizon's. It too has a positive net and dividend. And again, the differentiating factor is to a large degree its much lower debt-to-enterprise value ratio, which means lower costs on the "I" line.
The key factor for Sprint in terms of forward stock price trajectory is going to be whether it can start generating the cash flow to either pay down the debt or diminish it as a percentage of the firm by growing the company's operations. Another large influence that is underappreciated is that unlike the other two, Sprint should be spending less over time on network build (as a percentage) because its LTE implementation will only be done once instead of twice. This will become more evident over the next three to five years as the retrofit costs are likely to bite into AT&T and Verizon, where Sprint will have evaded that expense by waiting and buying once-- smartly -- instead of buying first.
Given today's facts and figures, the stock looks reasonably valued. However, if the company continues to execute a second double is entirely possible -- indeed, it is reasonable over the next two to three years assuming it is able to start generating positive bottom-line EPS.
Note that this is is a net deterioration over my previous view, where I thought we might see as much as a triple. That is due not to Sprint's execution, but rather due to margin pressure in the wireless space as a whole. This is a trend that isn't going to be kind to anyone, but Sprint remains in the best position in that its undervaluation, assuming continued execution, leaves room for additional price appreciation while Verizon and AT&T are living on their dividend streams. Should anything happen to their ability to sustain that...
Technically, the stock is behaving extraordinarily well. It had been following a trendline upward since June, and while there was one violation that looked to be potential trouble on its last earnings release, the stock hopped right back up over that trendline and resumed climbing. The pattern of generating large pops, which then ultimately come back in to the 50% level of the former advance before accelerating again, is one that has played out twice in the last few months. The first of these moves, which was punctuated by the earnings release, did not give you a clean entry before going to the -61.8% and terminating there. The next one did, but repeated the target achievement. The current advance, if the pattern is followed, should run to somewhere around $6.25 or so and the pullback (which was your best entry point) came around $4.65.
AT&T and Verizon's charts, on the the other hand, both have potential double-tops on the board. In my opinion, neither is buyable unless there is a breakout, but at the same time neither is a particularly attractive short. While both have seen decent price appreciation this year, the alpha play on a percentage basis has clearly been Sprint, not the others.
We are forced by the market distortions engaged in by central banks and governments to become speculators and to reduce duration risk or the odds of being creamed by events entirely outside of our control rise to unacceptable levels for the potential returns available in the market. As such, being an investor in the classical sense is, in my view, a fool's game in today's environment. Unfortunately, this combination of factors and the chart leads me to believe that unless we get a pullback in the stock to around $5.20 you've got no clean buy here, as the rational place for a stop is just over $5. If you buy here, you're looking at a potential 10% or greater loss, which I find unacceptable. In addition, the options are expensive, with January $6 calls going at present for about 50 cents, which puts the breakeven above my current short-term target and thus are rather unattractive. Annoyingly, the company's next earnings release is after October expiry, making the $6/7 call spread a gamble that doesn't look that attractive, either. Although if we do get the ramp to around $6.40 and if you're quick that spread could provide a decent profit, given that it's only about 11 cents this morning.
However, if you're in the stock currently, unless $5.20 is violated on a closing basis I continue to like sitting on the position and letting the market tell me what to do. At $6.25 the stock would be substantially overvalued based on my current look at financial performance, but should the upcoming earnings release show continued positive cash flow acceleration, that valuation could suddenly look very reasonable indeed.
Disclosure: I am long S.