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The communications services industry is renowned for the high dividend yield offered by its constituents. A relatively safe yield of 4% to 5% is quite common. Thus the sector is considered attractive by many income investors, especially since the yield on the treasuries is less than 2%. In this article, I will examine four major global communication service companies and present my fair value analysis results.

The companies selected for analysis include BT Group (NYSE:BT), Verizon (NYSE:VZ), Vodafone Group (NASDAQ:VOD) and AT&T (NYSE:T). BT and VOD are non-U.S. firms with their ADRs trading on the U.S. exchanges. Some basic information about these companies is presented in the table that follows:


BT

VZ

VOD

T

Market Cap (Billion)

$27.69

$127.1

$138.4

$205.5

Debt to Market Cap

42%

41%

25%

31%

Stock Performance 5 Yr

-45%

-2%

-23%

-16%

Stock Performance 1 Yr

27%

23%

7%

25%

Dividend Yield

3.7%

4.6%

5.3%

4.9%

All four firms are fairly large in size, with AT&T leading the way with a market capitalization of over $200 billion. BT is the relatively smaller firm, with a market capitalization of approximately $28 billion. The company is based out of London, UK and has operations in over 170 countries. VOD and VZ are similar sized firms with market capitalization in the range of $127 billion to $138 billion. The dividend yield offered by the four companies is impressive, ranging from 3.7% for BT to 5.3% for VOD. BT, VZ and T all outperformed the broader markets during the last 1 year. VOD was the only laggard in this group, appreciating by 7% compared to the 24% return of the S&P500.

Next, I evaluated the historical growth rates of revenue, income and EPS, and the projected growth rates. These are summarized in the table shown below:


Growth Rates

BT

VZ

VOD

T

Revenue

10 Year

0%

5%

4%

11%

5 Year

-1%

5%

8%

15%

1 Year

-6%

4%

1%

2%

Income

10 Year

-3%

-5%

-

-4%

5 Year

-7%

-17%

-

-12%

1 Year

33%

-6%

-13%

-80%

EPS

10 Year

-2%

-5%

-

-9%

5 Year

-6%

-17%

-

-19%

1 Year

32%

-6%

-9%

-80%

Book Value

10 Year

-1%

0%

-3%

6%

5 Year

-1%

-1%

-2%

9%

1 Year

1%

0%

-3%

0%

Growth Projections

Next Year

2%

14%

4%

8%

Next 5 Year

5%

11%

8%

10%

VZ has had consistent revenue growth rates over the last 10 years; however, the net income has declined over the time period. VOD reported a loss during the early part of the last decade. Its net income fell by 13% last year. AT&T's booked some onetime charges last year when the deal to acquire T-Mobile fell through which was responsible for the sharp drop in profits last year. Going forward, analysts expect the companies to grow at an annual rate ranging from 5% for BT to 11% for VZ.

Having analyzed the historic and projected growth rates, I looked at the operational metrics such as gross and operating margins. The table that follows presents the evaluation results.


Margins

Averages

BT

VZ

VOD

T

Gross Margins

10 Year

57%

60%

38%

56%

5 Year

63%

59%

35%

59%

Last Year

59%

59%

32%

55%

TTM

59%

60%

32%

55%

Operating Margins

10 Year

12%

16%

-

16%

5 Year

9%

14%

20%

15%

Last Year

15%

12%

24%

7%

TTM

15%

13%

24%

8%

BT has increased its margins over the last few years although the gross margins did fall last year compared to the 5 year average. Its operating margins are also encouraging. VZ and T have fairly consistent gross margins, while the operating margins have gradually declined over the past decade. VOD's gross margins are disappointing in my opinion.

Having developed a good idea about the fundamentals of the 4 companies, the next step was to perform relative valuation. The multiples used in the analysis were based on historical analysis of individual company and industry multiples.

The table below presents the valuation analysis results.


Valuation

BT

VZ

VOD

T

Next Yr Proj EPS

$3.89

$2.83

$2.60

$2.58

EPS Growth Rate

5%

11%

8%

10%

Future EPS (5 Yr)

$4.68

$4.19

$3.35

$3.67

Expected P/E

12

19

13

17

Price 5 Yrs Out

$56.21

$79.52

$43.54

$62.45

Unlevered Beta

1.06

1.06

1.06

1.06

D/E Ratio

42%

41%

25%

31%

Current Tax Rate

35%

35%

35%

35%

Levered Beta

1.35

1.34

1.23

1.28

Risk Free Rate

2%

2%

2%

2%

Risk Premium

6.00%

6.00%

6.00%

6.00%

Size Premium

-0.36%

-0.36%

-0.36%

-0.36%

Cost of Equity

9.7%

9.7%

9.0%

9.3%

Fair Value

$36.18

$51.23

$28.87

$40.94

Current Price

$35.16

$44.62

$28.15

$35.6

% Overvalued

-3%

-15%

-3%

6%

As shown in the table above, VZ and T are grossly undervalued and appear compelling at current levels. BT and VOD are slightly undervalued. Considering the dividend yield, I would buy VZ and T at current levels and treat corrections in stock prices of BT and VOD as a buying opportunity.

Source: Telecom Giants: 4 Buying Opportunities