Our Outlook for the Telecom Sector
A pullback provides opportunities in the defensive telecom sector.
A pullback provides opportunities in the defensive telecom sector.
<< Return to Main Market Outlook Page
In previous quarterly updates, we've talked a lot about the virtues of international telephone companies. As we discussed, one of the nice features of telecom firms is the significant cash flows they generate.
For many incumbent fixed-line operators, the amount paid by customers is a flat fee, regardless of usage. Although the number of subscribers is declining because of increased competition, particularly from cable operators now offering phone service and from customers choosing to go wireless and use only a cell phone, the decline in revenue is mostly being offset by new services offered, such as high-speed Internet access. On the other hand, many customers of wireless telephone firms, especially in emerging markets, are on prepaid plans that do depend on usage. However, many of these countries are still adding subscribers at rapid rates that will offset declines in some customers' usage.
The reality is, very few people who have had a phone will choose to go without one. The phone has become a necessity, not a luxury.
In volatile economic times like these, the cash flow from a needed service is particularly nice to have. Ultimately, the value of a firm is the present value of its future cash flows. The value of a company that has more predictable cash flows should increase relative to other firms with less predictable cash flows when markets are concerned about economic issues and the sustainability of revenues, margins, and cash flows. In addition, international companies are less likely to be as directly affected by the weak U.S. economy.
Valuations by Industry
Despite the defensive nature of the telephone sector, many of the stocks in the sector have had a significant pullback.
Telecom Industry Valuations | |||
![]() | ![]() | ![]() | ![]() |
Segment | Current Median Price/Fair Value | Three Months Prior | Change (%) |
![]() | |||
Telecom Services | 0.88 | 0.99 | -11.1 |
![]() | |||
Wireless Services | 0.95 | 1.02 | -6.9 |
![]() | |||
Data as of 03-14-08. |
For the past several quarters, the telecom sector has been one of the most overvalued sectors Morningstar covers, and we have had a hard time finding companies to highlight. The wireless services sector is still one of the higher-valued sectors, but its median price to fair value ratio is now below 1, implying it's slightly undervalued. The telecom services industry is now middle of the pack versus other sectors, and the median stock in this industry is 12% undervalued.
In the last quarterly update, we noted that Sprint Nextel was the only telecom stock trading below our consider buying price. We continue to like Sprint and think it is now trading below the value of the spectrum it owns, based on the value of the currently ongoing spectrum auction. The 50 million subscribers and plant and equipment are thrown in for free.
Telecom Stocks for Your Radar
In keeping with our international theme, we're pleased to see that five international stocks are now trading below their consider buying price. Along with generating lots of cash, four of these five return some of that cash to shareholders with above-average dividends, though we expect Telecom Italia (TI) to cut its dividend, so the trailing yield of 9.1% will most likely not be the yield going forward.
Stocks to Watch--Telecom | |||||
![]() | ![]() | ![]() | ![]() | ![]() | ![]() |
Company | Star Rating | Fair Value Estimate | Economic Moat | Risk | Dividend |
![]() | |||||
BT Group | ![]() | $69 | Narrow | Average | 7.4% |
![]() | |||||
NII Holdings | ![]() | $64 | Narrow | Above Avg | 0% |
![]() | |||||
SK Telecom | ![]() | $38 | Narrow | Above Avg | 5.1% |
![]() | |||||
Telecom Italia | ![]() | $34 | Narrow | Average | 9.1% |
![]() | |||||
Telkom Indonesia | ![]() | $65 | Narrow | Above Avg | 3.2% |
![]() | |||||
Data as of 03-19-08. |
BT Group
Our thesis for BT Group continues to play out with growth in "new wave" services offsetting the decline in traditional phone calls. We don't see any reason this will change. The firm's management has done a great job of developing a strategy and then executing the plan. BT is transitioning from a highly regulated provider of basic telephone services in the U.K. into a full-fledged supplier of technology services. After several acquisitions, the firm is now a global force in information, communications, and technology services.
NII Holdings
NII Holdings has a strong position as a niche wireless provider serving the Latin American business market. Improving economic conditions in Latin America have helped the firm generate strong profitability and returns on investment. However, NII competes alongside telecom giants that dwarf its size and resources. NII's performance has been outstanding over the past few years. Although most wireless operators in Latin America are focusing on the fast-growing prepaid retail segment, NII has directed its operations toward corporate customers demanding instant connectivity.
SK Telecom (SKM)
Intensifying competition in South Korea's telecom industry will likely hurt SK Telecom's profitability during the next couple of years, but the firm's dominant size and expertise in the market should help preserve its leading position and generate decent growth going forward. SK is the head of the pack in South Korea's wireless industry, commanding more than half the nation's mobile-phone users, while its two rivals, KT Corp. and LG Telecom, control the rest of the market. Korea has consistently been an early adopter of technology, making constant innovation a key to staying competitive. Through providing a broad array of value-added data features, such as mobile banking, the firm has been able to attract and secure some of the nation's most valuable customers, which in turn has allowed it to generate the highest average revenue per customer in Korea.
Telecom Italia (TI)
Telecom Italia is the incumbent telephone operator in Italy and remains the leader in fixed-line, wireless, and high-speed Internet access services. Although only the Internet business is showing much growth, these businesses continue to generate significant cash flow, which the firm has been using to expand internationally. With minimal growth in its home market, TI is increasingly looking elsewhere for growth. It has 3.3 million Internet access subscribers in other European countries and has been expanding fairly aggressively, including the 2007 acquisition of Time Warner's Internet access business in Germany. TI also has a nice position in Brazil. It owns 81% of TIM Participacoes (TSU), which has been the fastest-growing wireless operator in Brazil.
Telkom Indonesia (TLK)
Although competition is growing in Indonesia's telecom industry, we believe that Telekomunikasi Indonesia's (Telkom's) advantages will allow the firm to maintain its dominance. Indonesia's telecom market, which serves the world's fourth-most-populous nation, has experienced rapid growth over the past few years. The country's wireless customer base doubled to about 60 million in less than three years' time. Despite this expansion, wireless penetration rates remain low, at about 35%, presenting tremendous growth opportunities.
If you'd like to track and analyze the stocks mentioned above, click here to create a watch list. Then simply click "continue," name your watch list, and click "done." (If this link does not work, please register with Morningstar.com--registration is free--or sign in if you're already a member, and try again.) This will allow you to save and monitor these holdings within our Portfolio Manager.
Other Sector Outlook Articles
Allan C. Nichols does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.
Transparency is how we protect the integrity of our work and keep empowering investors to achieve their goals and dreams. And we have unwavering standards for how we keep that integrity intact, from our research and data to our policies on content and your personal data.
We’d like to share more about how we work and what drives our day-to-day business.
We sell different types of products and services to both investment professionals
and individual investors. These products and services are usually sold through
license agreements or subscriptions. Our investment management business generates
asset-based fees, which are calculated as a percentage of assets under management.
We also sell both admissions and sponsorship packages for our investment conferences
and advertising on our websites and newsletters.
How we use your information depends on the product and service that you use and your relationship with us. We may use it to:
To learn more about how we handle and protect your data, visit our privacy center.
Maintaining independence and editorial freedom is essential to our mission of empowering investor success. We provide a platform for our authors to report on investments fairly, accurately, and from the investor’s point of view. We also respect individual opinions––they represent the unvarnished thinking of our people and exacting analysis of our research processes. Our authors can publish views that we may or may not agree with, but they show their work, distinguish facts from opinions, and make sure their analysis is clear and in no way misleading or deceptive.
To further protect the integrity of our editorial content, we keep a strict separation between our sales teams and authors to remove any pressure or influence on our analyses and research.
Read our editorial policy to learn more about our process.