By Carla Pasternak
When it comes to picking telecom stocks, are investors nuts?
I ask this because they have been clearly bullish on U.S. telecom Verizon (NYSE: VZ), which offers a 5% yield yet only 4% year-over-year revenue growth, instead of telecom stocks with higher yields and revenue growth. As a result, Verizon has returned more than 10% during the past year and three-year annual average gains of 16%.
Contrast this with Israeli telecom Partner (Nasdaq: PTNR), for instance. Despite a hefty 8% yield and annual revenue growth of more than 10%, Partner has underperformed its telecom peers and the broader market.
At first glance, Partner's weak market performance makes no sense. But, as I tell readers of my High Yield Investing advisory, telecoms are tricky to analyze. Financial statements don't tell the whole story. One-time events can swell revenue and earnings, yet growth may not be sustainable. The true test of sustainable growth for a telecom lies in the mix of a three key industry metrics:
• Subscriber growth
• Average revenue per user/unit (ARPU), which measures monthly revenue per subscriber or device
• Churn rates, which measure the percentage of connections that are lost each quarter.
Applying these three metrics, Partner's languishing share price and Verizon's strong gains in the past few years are entirely justified. Let me explain...
Although Partner has seen healthy double-digit revenue growth in the past year, these gains were mostly driven by the March 2011 acquisition of Israel-based telecom Smile 012. In addition, an increasingly growing churn rate of 7.2% in the fourth quarter of 2011 indicates the company is losing customers and market share to the competition.
Verizon's revenue, on the other hand, barely budged in the fourth quarter of 2011. The company's domestic wireless connections grew by 6% compared with the year-ago period, while the average revenue per unit increased by 2.3%. Its churn rate of 1.2% actually declined by 10% during the same period.
As it turns out, investors are quite sensible when it comes to picking telecom stocks.
Keeping this tale of two telecoms in mind, I went looking for attractive high-yield telecoms that sport sustainable growth. First, I narrowed my choices to about 24 stocks that trade on the Nasdaq or the New York Stock Exchange and carry a forward yield of 5% and up, based on dividend payout estimates.
I then searched for the telecoms with the best year-over-year growth rates, the lowest churn rates as well as changes in subscriber addition after losses and average revenue per user. For all these measures, I focused on wireless services, as this segment represents the main growth area for the majority of the telecoms in this group.
Here are what I consider to be the best of the group...
It's important to keep in mind that a loss of high-margin, post-paid (contract) subscribers raises more concerns than a loss of less profitable wholesale connections provided to other retailers or prepaid (pay-as-you-go) subscribers. In addition, post-paid subscribers who use smartphones are bigger spenders on data such as video downloads than users of standard cellphones.
For example, Verizon increased subscriber connections by 6% last year. This growth came from an increase in the number of new connections after net of losses compared with the previous year. While new wholesale connections declined a whopping 53%, there was a healthy 68% increase in more lucrative post-paid retail subscribers under long-term contracts.
In contrast, Montreal-based Bell Canada, a subsidiary of BCE (NYSE: BCE), enjoyed a 3% increase in the total number of wireless subscribers in 2011 compared with 2010. But the real story is that aggressive pricing from competitors led to a 13% decline in net additions of profitable post-paid customers. What saved the day for this telecom is that 48% of its post-paid subscribers bought data-hungry smartphones by the final quarter of the year, up from 31% in same period of 2010.
Like Verizon, Bell reported year-over-year increases in average revenue per user. They also enjoyed some of the lowest average wireless churn rates among the group, with 1.2% for Verizon and 2.1% for Bell, during the fourth quarter of 2011.
Besides Verizon and Bell Canada, wireless provider NTELOS (Nasdaq: NTLS) posted a fairly strong performance. NTELOS had a 4% decline in its subscriber base year-over-year, but average revenue per user held relatively steadily, with less than a 1% decline. The company also registered a steady and fairly low churn rate of 3.7% at the end of the third quarter of 2011.
It's no coincidence these three high-yielding telecoms are also among the market's top performers. Verizon's 6% and Bell's 8% average annual returns during the past five years are far ahead of the benchmark S&P 500, which has barely returned 1% in the same period. Meanwhile, NTELOS shares have been going like gangbusters, returning an impressive 19% so far this year, more than twice the benchmark index.
Risks to Consider: The telecom industry is in a constant state of flux. A company's metrics can change quickly from year to year, or even from quarter to quarter, in response to changes in technology, government regulations, competitive forces and acquisitions, among other events. As such, this list should be treated simply as a springboard for further research.
Of the three telecoms, Verizon's numbers look the best. In fact, I own shares in my High-Yield Investing portfolio. But I've also have my eye on NTELOS and Bell Canada, which are also worth researching further for their hefty yields and sustainable growth.
Disclosure: Carla Pasternak does not personally hold positions in any securities mentioned in this article. StreetAuthority LLC owns shares of VZ in one or more if its “real money” portfolios.