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Stocks to Buy – General Communication

This small cap stock shows its growth potential

   

There are so many complicated companies that demand our attention. Don’t you think sometimes it would be nice if we could go back to the good old days and just own a good old telephone utility like our grandparents used to do?

Well here’s one: General Communication (GNCMA), an Anchorage-based telecommunications company that is up nearly 13% since last month. I like this story because it appears to come out of nowhere, and yet it makes perfect sense.

GenComm provides internet service and cable television to 70% of Alaskan residents and wireless and landline service to 20%. Bundled services make it easy for customers to meet all their telecom needs in one place: 59% of customers purchase three of more of the company’s services. One Alaskan resident wrote, “If I wanted to leave GCI entirely, I would have to deal with four different companies to get comparable service, and it would cost a lot more.”

While many states face record deficits, Alaska has been fairly sheltered from the recession by oil royalties. The state government ran an estimated $400 million surplus in 2009. This provides a strong undertow of growth for Alaska-based firms.

Alaskans spend 33% more on communications services than other Americans, and median disposable household income is 15% higher than the U.S. average. This higher disposable income translates into increased demand for high-margin services such as high definition video and digital video recording. The company claims to offer the fastest broadband service in a state where many residents are isolated from each other and crave electronic communications in a more profound way than seen in more urbanized areas. Video and internet revenue are up 6% year over year.

With the acquisitions of Alaskan Wireless, Digitel, and Unicom, the launch of the Galaxy 18 satellite, and the upgrade of its GSM network, General Communications reported 34% wireless subscriber growth in the past year. Over the next five years, wireless revenue is expected to grow from 15% to 33% of total sales.

Near term growth is also promising. Its latest earnings report showed that overall sales were up 7% year over year, while profits jumped 17%. With a net profit margin under 1%, GCI’s $421 million market cap is smaller than its $600 million in annual sales. This results in a price to sales ratio of 0.7, indicating that GCI has been unpopular with investors until very recently.

Stocks with price to sales ratios less than 1.0 and high relative strength have significantly outperformed the S&P 500 on an absolute and risk-adjusted basis in the past 40 years, according to a study by Jim O’Shaughnessy. GNCMA fits this profile to a T, so to speak.

GenComm’s shares were trading within a small band on low volume for most of the past eight months. Then In mid-June, the shares suddenly leaped from obscurity on high volume as investors discovered a company with strong growth prospects operating in the stable Alaskan market.

The firm carries a sizable debt load associated with the construction of a statewide network. In the first quarter, 90% of its operating earnings were used to cover interest payments. The company may face liquidity problems if it cannot refinance debt due in 2011 and 2012.

While risky, the use of financial leverage also magnifies any upside. Analysts expect General Communications to improve its profit margin from .81% to 2% because its statewide network is nearly finished. Future investment is limited, and earnings will skyrocket as fixed costs decrease and subscribers increase.

Analysts expect the company to earn 18 cents per share in 2011, but earnings are deceptive in a low-margin company like this. It’s better to use revenue, and I expect that the shares are starting to move toward a more common multiple for regional telecom carriers of 1.3x sales. Even if you just look for a 1x multiple, the price target is $11, which implies 36% upside from here.

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Article printed from InvestorPlace Media, http://investorplace.com/2010/07/stocks-to-buy-general-communication/.

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