After navigating through choppy waters that at one point appeared to be signaling doom, telecom stocks have experienced a strong revival in recent weeks.
Since the first of October, the benchmark telecom stocks’ exchange-traded fund iShares Dow Jones U.S. Telecom (IYZ) is up 10%. On a year-to-date basis, the IYZ is in the black to the tune of 1.5%, exceeding the performance of the broad SPDR S&P 500 ETF Trust (SPY), which has undergone a remarkable recovery in its own right.
Typically, telecom stocks are built on solid foundations that investors find highly attractive. First and foremost is the growth potential, with earnings per share for telecoms projected to nearly quadruple that of stocks represented by the S&P 500. Second on the list are the returns from passive income, with dividend yields from telecoms averaging nearly 5% whereas the broad indices only offer a relatively meager 2%.
Another factor not commonly discussed is that U.S. telecoms accrue most of their sales domestically. In an age of global central banks constantly vying for monetary leverage, direct exposure to foreign currency dynamics could spell disaster for many organizations if the wind blows in an unfavorable direction. Amid a sea of macroeconomic worries, telecoms can at least put that one concern aside.
However, not everything is sunshine and roses for telecom stocks. The markets overall have not been kind for the sector, with the IYZ fund just shy of parity on a year-over-year basis. Much of that volatility is due to reduced sentiment for high-yield stocks in an environment of rising rates. With financial analysts speculating that the U.S. Federal Reserve will eventually raise rates sooner rather than later, investors of telecom stocks have every reason to be anxious.
Despite the short-term turnaround, don’t expect too much from telecoms, which may ultimately end up luring investors into a bull trap. Here are three telecom stocks that are especially deceptive.
Telecom Stocks: Frontier Communications (FTR)
At first glance, it’s hard to fault contrarians for considering taking a risk on Frontier Communications (FTR). One of the telecoms servicing the needs of smaller regions in the U.S., it features an all-American workforce — a true enigma in our globalist society.
With a YTD loss of nearly 28% pushing FTR stock’s book value per share to 0.93, there’s extreme value here if one is willing to risk the volatility. By way of comparison, the telecoms’ giant AT&T Inc. (T) is priced at 1.6 times its book value.
However, this is where the good news ends. FTR stock’s ability to generate a profit is under serious question as its severely declining operating margins pressure trailing revenue. The recent third-quarter earnings report did nothing to assuage matters, as EPS figures were down 40% year-over-year. The consequence came in the form of a 7% drop in FTR stock.
Technically, this sets up a dangerous situation in the markets.
Since late July, FTR stock has been gyrating in a relatively narrow consolidation range. However, its inability to break above a clear resistance line at $5.50 is concerning. Volume has been extremely heavy under selling, and while that could signal an exhaustion of bearish activity, it may also mean a lack of broad interest. Finally, FTR stock’s lofty yield of 8.7% is questionable in the face of a potential rate hike.
Taken as a whole, the message is quite clear — don’t touch FTR stock, as there are too many problems with its future viability.
Telecom Stocks: Verizon (VZ)
As the largest wireless carrier in the U.S. and with a market capitalization hitting $189 billion, Verizon Communications Inc. (VZ) is by far the undisputed king of telecoms listed in this comparison.
However, even royalty isn’t immune to its fair share of problems. Late last month, Verizon announced that it will initiate a massive reorganization plan that will eventually reduce the number of regional offices by 70%, though the number of workers affected remained unspecified as of yet.
While contrarians may view the reduction in cost as a positive for VZ stock’s equity value, the markets remain cautious. Since the announcement of the layoffs, VZ stock has barely budged, moving down a miniscule three cents. This sharply contrasts with Verizon shares’ 9.5% swing since October 1.
More critically, since early June, VZ stock appears to be forming a broadening wedge pattern, a technical formation characterized by wild gyrations in the markets that increasingly grow in magnitude.
Although VZ stock’s fundamentals are more solid than many other telecom stocks, its neither a great nor a bad deal based on its price-to-earnings ratio of 18.4 — a mere 2% lower than the industry average of 18.8. Against book value, though, the story is far different. With VZ stock priced at more than 14-times book value, it dwarfs the industry average of 2.2. Furthermore, earnings per share have tumbled in the past 12 months.
While VZ stock’s price is under pressure, that doesn’t mean it’s undervalued. Verizon’s volatile behavior in the markets is evidence enough that the telecom stock’s returns do not justify the risks.
Telecom Stocks: Centurylink (CTL)
If recent news were any indication, life is good for investors in Centurylink (CTL). Since bottoming in the beginning of last month, CTL stock is up nearly 16%, blowing past its 50 day moving average. CTL runs in the middle of the pack among telecoms with a market cap north of $16 billion. and Wall Street is expecting strong numbers for CTL stock’s Q3 FY2015 earnings results.
Wall Street expected strong numbers from CTL’s third quarter report, and the company managed to deliver.
However, this may be a case of too much, too soon. Recently, analysts raised their Q3 EPS target to 70 cents from 64 cents. Under ordinary circumstances, the bump up reflects welcomed optimism. In CTL stock’s case, the raise puts the current Q3 estimate at nearly 13% higher than from a year ago level. In addition, revenue growth has been challenged by steadily lowered gross and net margins, which makes the EPS target all the more difficult to meet.
However, CTL stock’s performance in the markets is highly suspect. With a YTD loss of more than 28%,Centurylink shares are the worst performing among the three featured telecoms. Even with the recent resurgence, it will take something special for CTL stock to bounce back convincingly enough for most investors to take a risk. And as its yield approaches 8%, the implied volatility behind that figure may not be worth it in light of a potentially looming rate hike by the Fed.
CTL stock may look like a comeback kid on paper, but Wall Street may be expecting too much from what has historically been a very choppy investment.
As of this writing, Josh Enomoto did not hold a position in any of the aforementioned securities.
