U.S. Telecommunications Industry Outlook - April 2017

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The U.S. telecommunications industry is currently balanced with almost equal proportions of positive and negative influences. Ever since Donald Trump's presidential victory, the stock prices of most of the major telecom stocks have enjoyed a bullish run in the market through the end of the first quarter of 2017.

In a nutshell, the primary reasons behind this bull run were, firstly, the new-look U.S. telecom regulatory body - Federal Communications Commission (FCC) - has given enough indications that It will be less stringent compared with the Obama administration and is likely to roll back several stringent regulations of the previous regime. Secondly, the less restrictive nature of the FCC will aid mergers and acquisitions which will likely spur growth in 2017. Thirdly, expected corporate tax reform will benefit telecom operators.

However, several near-term headwinds continue to persist in the telecom industry. The chief ones include growing price competition for wireless services are likely to reduce carriers' revenue growth in 2017. Leading cable MSOs (multi-service operators) have decided to enter the wireless field in 2017 which is likely to intensify competition in an already saturated market.

Further, capital spending by the U.S. telecom carriers may be muted in 2017. The 4G LTE wireless penetration is currently 83% in North America. This can primarily be attributed to most carriers' intention to upgrade to 5G wireless network standard which requires massive investment. However, a full-phased 5G network deployment is unlikely before 2020.

FCC Under Trump

President Trump already has had quite an impact on telecom policy parameters. On Jan 2017, Trump elected existing Republican commissioner Ajit Pai as the new Chairman of the FCC. Ajit Pai is a staunch opponent of several laws and rules adopted by the FCC under former Chairman Tom Wheeler's regime, including Net Neutrality laws, rules to reform business data market and set-top box reform proposals. Notably, all three reform rules were going to hit the telecom operators and ISPs (Internet service providers) the most.

Recently, the U.S. Senate and House of Representative voted against a set of privacy rules for broadband service providers, proposed previously by the FCC under the Obama administration. On Oct 2016, the then FCC chairman Tom Wheeler had proposed these rules. However, the new FCC -- reconstructed by Trump with Ajit Pai at its helm -- voted to stay the rules of the previous regime on Mar 1, 2017.

What Are Broadband Privacy Rules? 

The broadband privacy rules proposed by former FCC Chairman Wheeler required ISPs to get consumers' explicit consent before selling or sharing Web browsing data and other private information with advertisers and other companies.Since ISPs have direct access to user database, they used to sell the data to digital marketing firms for targeted advertising. This was a major source of revenues for the ISPs.

It is important to note that ISPs like Verizon Communications Inc. (VZ), AT&T Inc. (T) and Comcast Corp. (CMCSA) are governed by FCC rules. On the other hand, Internet firms such as Facebook Inc. (FB), Twitter Inc. ( TWTR ) and Alphabet Inc. (GOOGL) come under the Federal Trade Commission (FTC) regulations. At present, there are no rules governing data disclosure by Internet firms.

As a result, the 'Opt In' ruling will be an advantage. However, the FCC had assured the ISPs that it will try to harmonize the regulations with the FTC. Notably, all the stocks mentioned above currently carry a Zacks Rank #3 (Hold). You can see the complete list of today's Zacks #1 Rank (Strong Buy) stocks here .

ISPs to Cheer Now

The digital advertisement market space is growing exponentially and ISPs have been increasingly investing resources to cash in on the bountiful opportunities. However, the FCC's previous directive stipulated that the ISP should notify customers before sharing any user data for advertising. This was certainly going to mar ISPs prospects in the business. Consequently, a new FCC body exercising lesser restrictions certainly augurs well for the ISP industry.

Key Attributes for 2017

(1) The telecommunications industry is essentially characterized by high barriers to entry. The deployment of network infrastructure requires significant capital expenditure, which very few entities can afford. Furthermore, it is not easy for a new telecom carrier to establish itself in the market as it requires government approval to transmit voice, data, and video. Such barriers protect the profits of incumbents.

(2) A major characteristic of the telecommunications industry is that it is immune to international geo-political disturbances, even when these lead to economic fluctuations. This is because the need to remain connected stems from our primal instinct to communicate with fellow human beings. Volatility in the global economy due to political and economic disturbance in the Eurozone, Asia-Pacific or the Middle-East has had little impact on the sector.

(3) Wireless network strength is the key to future growth of the overall telecom industry. As wireless networks run on radio frequency, spectrums (airwaves) are naturally the most sought after assets in the industry. Spectrum auctions conducted by the FCC from time to time will significantly boost network capacity.

(4) Telecom companies offer one of the highest dividend yields in the U.S. economy. Unlike other industries, U.S. telecom operators generate revenues predominantly in the country. This makes these stocks less susceptible to volatility in the foreign exchange rate as well as macro-economic fluctuations plaguing rest of the world. We believe the strong dividend yield momentum will continue as the U.S. economy slowly returns to stability.

(5) Mergers and acquisitions (M&A) are not uncommon in the U.S. telecom industry. Telecom and pay-TV operators often join forces to provide better and attractive bundled products to customers. In order to stay ahead of competition, existing players need to be constantly on their toes to introduce innovative products or merge with other companies. In the near future, the U.S. telecom industry is likely to witness further mergers and acquisitions along with product diversifications.

Upcoming 5G Wireless Technology

According to a study commissioned by Qualcomm, fifth-generation (5G) wireless technology could result in real global economic growth by $3 trillion cumulatively from 2020 to 2035. Several industry researchers hold that 5G network will provide a download speed of 1 Gbps (gigabit per second), which is 200 times the throughput of the currently available standard 4G LTE network. Latency period of data delivery will be in single milliseconds. Further, 5G technology is designed to be more power efficient than any other standard wireless network available at the moment. Naturally, 5G-enabled mobile devices are likely to last much longer than their 3G or 4G counterparts.

In July 2016, in a landmark voting, the FCC unanimously decided to make available high-frequency radio spectrums (above 24 GHz) for the use of the upcoming 5G wireless network. With this, the U.S. becomes the first country in the world to identify and open up a significant amount of spectrum suitable for the ultra-fast 5G mobile standard. At present, all four major national wireless operators, namely, Verizon, AT&T, Sprint Corp. (S) and T-Mobile US Inc. (TMUS) are conducting trial runs for 5G wireless standards.

Valuation Calls for Stabilization

Going by the P/E (price to earnings per share) valuation metrics, which is often used to value telecom sector stocks, the industry looks a bit expensive at this stage. The industry currently has a trailing 12-month P/E ratio of 22.13x, which is higher than the median value of 20.73x in the past year.

Additionally, the reading compares unfavorably with the market at large, as the current P/E for the S&P 500 is pegged at 20.31x and the median level is 19.26x. At present, the telecom sector looks overvalued compared to the overall market. This indicates a near-term stabilization for the companies.

Another commonly used valuation metrics for this sector is P/S (price to sales) which depicts a similar picture. The industry's current P/S of 3.12x compares unfavorably with the market at large, as the current P/S for the S&P 500 is at 3.08x and the median level is 2.89x.

What the Zacks Industry Rank Indicates

Within the Zacks Industry classification, Telecommunications is broadly grouped in the Computer and Technology sector (one of the 16 Zacks sectors) and is further sub-divided into 12 industries at the expanded level: Communications Infrastructure, Communications Components, Satellite Communications, Cable TV, Diversified Communications Services, Internet Services, Wireless Equipment Supplier, National Wireless Service Provider, Rural Wireline Operator, Non-U.S. Wireless Operator, National Wirleline Operator and Non-U.S. Wireline Operator.  The level of sensitivity and exposure to different stages of the economic cycle vary for each industry.

We rank all the 265 industries in the 16 Zacks sectors based on the earnings outlook and fundamental strength of the constituent companies in each industry. To learn more visit: About Zacks Industry Rank . As a guideline, the outlook for industries with a Zacks Industry Rank of #88 and lower is 'Positive,' those between #89 and #176 is 'Neutral' while for those with #177 and higher is 'Negative.'

The Zacks Industry Rank for Communications Infrastructure is #208, Communications Components is #99, Internet Services is #186, Satellite Communications is #228, Cable TV Operators is #48, Diversified Communications Services is #63, Wireless Equipment Supplier is #75, National Wireless Operators is #210, National Wireline Operators is #107, Rural Wireline Operators is #236, Non-U.S. Wireless Operators is #34 and Non-U.S. Wireline Operators is #52. Looking at the Zacks Industry Rank of the 12 telecommunications industries, we believe that the near-term outlook for the group is tending more toward 'Neutral.'

Earnings Trend in the Sector

The broader Technology sector, of which the telecommunications industry is part, delivers a strong show with respect to earnings. All sector participants have reported fourth-quarter 2016 financial results, which have been impressive in terms earnings and revenue growth. Total earnings for the reported companies have shown a strong 9.1% year-over-year increase owing to 5.6% growth in revenues. This compares favorably with an earnings growth of 5.2% in the third quarter of 2016. Revenues witnessed a decline of 1.0% in the same quarter.

Meanwhile, the consensus earnings expectation for the next two quarters depicts an impressive trend. While earnings growth is anticipated to grow 10.2% in the first quarter of 2017, it is likely to grow 7.7% in the second quarter. Similarly, revenue is expected to grow 6.7% year-over-year in the first quarter of 2017 and another 6.2% in the second quarter.

For a detailed look at the earnings outlook for this sector and others, please read our weekly Earnings Trends reports.

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Verizon Communications Inc. (VZ): Free Stock Analysis Report

Twitter, Inc. (TWTR): Free Stock Analysis Report

T-Mobile US, Inc. (TMUS): Free Stock Analysis Report

AT&T Inc. (T): Free Stock Analysis Report

Sprint Corporation (S): Free Stock Analysis Report

Alphabet Inc. (GOOGL): Free Stock Analysis Report

Facebook, Inc. (FB): Free Stock Analysis Report

Comcast Corporation (CMCSA): Free Stock Analysis Report

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

This article appears in: Investing , Business , Investing Ideas , Stocks
Referenced Symbols: VZ , TWTR , TMUS , T , S

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