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What Toll Has Been Taken on Telecoms?

What Toll Has Been Taken on Telecoms?

Editor’s note: Read the latest on how the coronavirus is rattling the markets and what investors can do to navigate it.

Michael Hodel, CFA:

Telecom stocks haven’t been immune to the market sell-off surrounding COVID-19 despite the industry’s relatively modest exposure. Most U.S. large-cap firms in the sector have dropped meaningfully in the recent weeks, allowing investors to purchase shares in businesses that should deliver consistent cash flow over time at good valuations, though not necessarily at “once in a lifetime” levels.

AT&T and Verizon both fall into this category in our view. Depending on the day--given the volatility in the market recently--the shares of these two firms have generally traded at a 10%-20% discount to our fair value estimates, with AT&T looking a bit cheaper to us at a dividend yield in the 6% range.

However, we would highlight wide-moat Comcast as our favorite U.S. telecom stock currently, with the shares trading at a roughly 25% discount to our $49 fair value estimate. The COVID-19 pandemic will hurt Comcast’s theme parks business and its movie studio, but its core cable business (which accounts for around 70% of consolidated EBITDA) and television operations within its NBC Universal segment should hold up very well.

Comcast’s theme park business generated nearly $6 billion of revenue in 2019, accounting for about 5% of consolidated sales. We know this segment's clearly going to have a very challenging 2020, but this is still a business that we like for the long term. The segment generates solid profitability while providing a key mechanism to support content franchises at NBC Universal. In addition, Comcast’s 30%-owned theme park in Beijing is still scheduled to open in 2021, adding another important location to the firm’s roster.

Comcast’s core cable business should perform very well over the course of 2020 in our view. The firm has rapidly taken market share in the Internet access business in recent years thanks to the strength of its network relative to the phone companies that it competes against in most places. While COVID-19 precautions could disrupt workflows, slowing down the rate of new customer installations, an increase in telecommuting and television streaming could further highlight Comcast’s network advantage in the coming weeks. Generally speaking, we expect the Internet access business will hold up well in response to economic pressure as connectivity has become central to a wide swath of daily life.

Comcast’s balance sheet isn’t as rock-solid as it was a couple of years ago thanks to the Sky acquisition, but it is still in great shape. Net debt to EBITDA sits a bit below 3 times, which compares favorably to Comcast's cable peers like Charter and Altice USA, which carry net leverage of around 5 times EBITDA. Comcast generates fantastic cash flow as well, and we expect it will reduce its net debt load by at least 10% during 2020 as it works to get its balance sheet back near pre-Sky leverage metrics.

From a valuation perspective, in addition to the discount to our fair value estimate, the stock is trading at an enterprise value--again depending on the day--of about 7 and a half or 7.6 times trailing EBITDA, down from more than 9.0 times in mid-February. This multiple isn’t quite as low as Comcast reached during the battle for Fox assets with Disney in 2018 (when it traded around 7.2 times EBITDA) nor is it close to the levels seen coming out of the financial crisis (the firm routinely traded at or below 5.0 times EBITDA for much of 2009 and 2010).

Still, we believe investors slant the odds of earning an attractive long-term returns in their favor buying a well-positioned firm like Comcast at current prices.

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