Picking Telecom Stocks? See Our DCF - Analyst Blog

By Zacks | July 03, 2012 AAA

Despite the lingering global economic woes, the U.S. telecom service providers are delivering consistent growth making their stocks attractive for long-term investments. Investors betting on telecom stocks should take into account our 50-year discounted cash flow (DCF) analysis for healthy returns amid stiff competition and stringent regulations. The top three U.S. mobile operators and service providers -- Verizon Communications Inc. (VZ), AT&T Inc. T) and Sprint Nextel Corp. S) appear appealing in the current market turmoil. Verizon and AT&T gained about 12% and 17%, respectively, during the first half of the year while Sprint surged 39% reflecting its turnaround story.

Our DCF Analysis

If we go by our 50-year DCF analysis, Sprint is the most undervalued stock followed by Verizon at the current levels. As of July 2, Sprint is trading at a massive discount of 158.46% while Verizon is trading at a substantial discount of 54%. On the other hand, AT&T is trading at a slight premium of 22.35%. 

Verizon, the U.S. wireless giant, is showing the largest consolidated revenue and earnings per share growth, each more than 3% over the next 50 years. Wireless revenue will also be the strongest at Verizon, increasing at a rate of 3.8% over the next 50 years. This excellent growth is reflected by the Zacks Consensus Estimate of $2.50 for fiscal 2012 and $2.79 for 2013, representing a significant growth of 16.17% and 11.52% year over year. Over the past three months, these estimates showed upward movements for Verizon. 

Both Sprint and AT&T are expected to grow more than 3% in revenue and 1.8% in earnings per share. Wireless revenue should grow at a CAGR (2012-2062) of more than 3% for the two carriers. As a result, the Zacks Consensus Estimates are trending up for AT&T while moving down for Sprint over the past three months.

The estimates for AT&T have increased by nickel to $2.38 for 2012 and by three cents to $2.54 for 2013, representing increases of 8.01% and 6.91%, respectively. Coming to Sprint, the Zacks Consensus Estimate is pegged at a loss of $1.58 for 2012, down 7 cents over the last three months and represents a drastic decline of 135.25% year over year. For 2013, the Zacks Consensus Estimate is down 12 cents at a net loss of $1.13, but is showing an upside of 28.45% year over year.

Over the next 10 years (2012-2022), revenue for these three carriers would grow nearly 3% each. However, earnings per share look highly attractive for Verizon with growth of 4.19% followed by 2.6% growth for AT&T. Notably, Sprint is expected to generate negative earnings per share growth of approximately 2.0%.

Why Invest?

Based on macro data points, these companies have a bright outlook in the years ahead. Most of the future growth of the telecom industry depends on the wireless business as subscribers are discontinuing landlines and moving quickly to wireless connections.

With the surging demand for data traffic, these carriers are expected to fuel exceptional growth based on their entrance into the cloud computing space and deployment of the most advanced 4G LTE networks across several markets. Further, smartphones, in particular Apple Inc.'s (AAPL) iPhones and Google Inc.'s (GOOG) Android-based handsets, tablets and 4G LTE will facilitate the companies to boost market share over the next several years.

Our Recommendation

Based on the expected strong financials and growth prospects, we find the shares of these major carriers intriguing options to play in the broad telecom sector.

We are maintaining long-term Neutral ratings on Verizon, AT&T and Sprint. For the short term (1-3 months), Verizon holds the Zacks #2 (Buy) Rank while AT&T and Sprint retain the Zacks #3 (Hold) Rank.

 
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