By
Morningstar
:
By Robert Goldsborough
Looking for exposure to rapid growth in the wireless
telecommunications industry in emerging markets, while at the same
time enjoying healthy levels of income and lower volatility?
Consider iShares S&P Global Telecommunications (
IXP
). This narrowly focused exchange-traded fund is an appropriate way
to tap into an attractive mix of stable, mature, U.S.-based telecom
firms, which make up about one third of this fund's assets, and
overseas wireless and land-line providers, many of which have
access to faster-growing emerging markets where phone penetration
levels have long runways ahead.
With a dividend yield approaching 5% and a three-year beta of
just 0.66, IXP offers stability at a time when many investors are
concerned about equity market volatility. And it provides unique
exposure as the only ETF to straddle the divide between U.S. and
foreign-based telecoms. The fund tilts heavily toward the largest
global telecoms, holding just 37 companies and devoting close to
70% of its assets to its top 10 holdings. However, many of IXP's
holdings have meaningful operations in rapidly growing emerging
markets, such as Vodafone (
VOD
), America Movil (
AMX
), and China Mobile (
CHL
).
Suitability
Given IXP's narrow focus, investors should treat this
exchange-traded fund as a tactical tool for the satellite portion
of their portfolios. IXP is also suitable for investors searching
for yield (with a yield of nearly 5%) and is suitable for investors
desiring a globally tilted ETF as an alternative to domestic-only
telecom funds. IXP is fairly concentrated; a few industry stalwarts
soak up the bulk of its assets.
Outside the United States, most phone companies have continued
to hold up fairly well as more customers adopt wireless and
high-speed Internet-access services. Although growth suffered
recently as customers cut back on wireless usage, most of the
telecom carriers that Morningstar's equity analysts follow continue
to generate significant free cash flows, which we expect will
provide stability. Given the risks inherent in IXP's underlying
holdings, an ETF is a good way to spread risks whenever telecom
valuations are attractive. Also, IXP is anchored by
industry-leading, cash-generating firms; the riskier firms here
make up the portfolio's tail and as a result don't hold much
sway.
Fundamental View
Since 2000, the telecommunications sector has matured in more ways
than one, shifting from an industry with high leverage, weak
profitability, and uncertain growth potential to one with solid
free cash flows and steady dividends. A big part of the industry's
maturing process has been the proliferation of wireless devices and
Internet usage. Wireless phones and Internet access both are now
viewed by almost everyone as necessities rather than as luxuries.
More than 90% of Americans now have a wireless phone and 77% of
Americans use the Internet. The phenomenon is by no means unique to
the U.S., as wireless penetration rates (defined as SIM cards per
person) in most of Europe are in the triple-digit range, and
emerging-markets countries are fast closing the gap.
Further, high penetration rates don't necessarily suggest a low
ceiling for growth. Demand for smartphones and mobile broadband
still is rising. Globally, Morningstar's equity analysts estimate
that smartphone sales will increase at a 30% clip for the next few
years. Recurring telecom services revenue tied to these devices is
likely to grow sharply over the next several years, as smartphone
users are more likely to surf the Internet and use multimedia
messaging services. We believe that the average revenue per
customer, or ARPU, can continue to rise even if competition
intensifies.
As wireless and Internet access services have grown, carriers
have begun to reap the rewards of past heavy network spending.
While telecom firms have continued to spend to add capacity, much
of the basic infrastructure needed to provide services already is
in place, and capital spending as a percentage of sales has
declined for many firms around the world. As a result, telecom
firms now generate hefty cash flows. Chastened by the telecom bust,
firms with questionable finances have used cash to retire debt
rather than make huge acquisitions or undertake major new projects.
As balance sheets have improved, telecom dividends have become more
sustainable and actually have increased in some cases. With juicy
dividend yields and improved balance sheets throughout the sector,
many telecom firms fit the profile of a traditional bear-market
investment.
Because of the telecom industry's wide-scale shift from
fixed-line to mobile services, the industry probably is less
recession-resistant than it was in the past. After all,
cash-strapped customers currently subscribing to bundled packages
or both fixed and mobile telephone lines can elect to either
discontinue their land lines or trade down to cheaper cable and
Internet services. In the past, when these companies primarily were
fixed-line operators, their customers had fewer communication
options, so the likelihood of mass contract cancelations was far
less. Also, outside the U.S., most wireless phone users still pay
on a per-minute basis, and as people use their phones less (both as
they migrate from voice to data and also from the economic
slowdown), that hurts the overseas telecoms' ARPU.
All risks considered, we think IXP could offer a compelling
investment opportunity. Ultimately, we believe that global demand
for phone, television, and Internet connectivity will continue to
expand. IXP's global exposure is a big positive, as investors can
partake in emerging markets' rapid adoption of telecom services
without assuming single-stock country risk. We'd also note that
there is a fair mix of exposure to corporate clients among the
fund's top holdings. In fact, revenues have shifted sharply toward
data and Internet services and away from traditional voice. As
businesses use networks to move more data around and drive basic
business functions, demand for connectivity among offices and
workers should continue to grow nicely.
Portfolio Construction
IXP seeks to replicate the performance of the S&P Global 1200
Telecommunication Sector Index--a subset of the S&P Global 1200
Index. Because the telecom sector contains a handful of behemoths,
this market-capitalization-weighted index is extremely top-heavy.
In fact, the top 10 holdings of this ETF soak up more than 69% of
assets. Further, the top five holdings-- AT&T (
T
), Vodafone, Verizon Communications (VZ), America Movil, and China
Mobile--comprise almost 52% of assets. U.S. companies make up more
than 35% of assets, with the United Kingdom, Japan, Mexico, Canada,
China, Australia, and France next in line with weightings of
approximately 14%, 8%, 6%, 6%, 5%, 4.5%, and 4%, respectively. More
than 97% of assets are parked in large-cap stocks, with the
remainder in mid-caps. The fund's average market cap, on a
holdings-weighted basis, is about $68.5 billion. IXP's portfolio
contains 37 stocks.
Fees
IXP charges a net annual expense ratio of 0.48%. Cheaper
alternatives do exist.
Alternatives
Investors seeking exposure to the telecom sector have several other
options, but it's difficult to find any funds that do not have
massive weightings in telecom behemoths like AT&T and Verizon.
For those drawn to IXP for its international flavor, SPDR S&P
International Telecom Sector (IST) (0.50% expense ratio) might be a
suitable alternative. Even though IST, which only holds telecom
companies not based in the U.S., does not hold AT&T or Verizon,
the ETF remains top-heavy, investing more than 63% of its assets in
its top 10 holdings. While IST does not own the two big domestic
heavyweights, Vodafone and Telefonica alone comprise more than 28%
of IST's entire portfolio. Investors should take note, however,
that IST is very small, with low trading volumes.
For broad-based U.S. exposure to the telecom sector, investors
should consider Vanguard Telecom Services ETF (VOX) (0.19% expense
ratio), iShares Dow Jones U.S. Telecom (IYZ) (0.47% expense ratio),
or the recently launched, very inexpensive (but still very thinly
traded) Focus Morningstar Communication Services Index ETF (FCQ)
(0.19% expense ratio), which holds 31 firms. Investors should be
aware that unlike the other funds, FCQ also holds cable companies
like Comcast (CMCSA) and Time Warner Cable (TWC).
Disclosure:
Morningstar licenses its indexes to certain ETF and ETN providers,
including BlackRock, Invesco, Merrill Lynch, Northern Trust, and
Scottrade for use in exchange-traded funds and notes. These ETFs
and ETNs are not sponsored, issued, or sold by Morningstar.
Morningstar does not make any representation regarding the
advisability of investing in ETFs or ETNs that are based on
Morningstar indexes.
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