The Zacks Diversified Communication Services industry appears to be mired in high capital expenditures for 5G infrastructure upgrades, unpredictable raw material prices, supply-chain disruptions amid the prolonged Russia-Ukraine war and Israel-Hamas conflict, China's soft market conditions and high customer inventory levels. However, the industry is likely to benefit in the long run from an accelerated 5G rollout and increased fiber densification.
Nevertheless, Swisscom AG, PT Telekom Indonesia and Telefonica Brasil S.A. should benefit in the long run from higher demand for scalable infrastructure for seamless connectivity amid the wide proliferation of IoT and transition to cloud network.
Industry Description
The Zacks Diversified Communication Services industry comprises firms that provide a wide array of communication services, including wireless, wireline and Internet, to business enterprises and consumers. These companies offer mobile and wireline telephone services, high-speed Internet, direct-to-home satellite television and other value-added services.
In addition to providing integrated information and communications technology services to businesses and governments, some of these companies operate as local exchange carriers or full-service providers of data center colocation and related managed services in state-of-the-art data center facilities. Some industry participants also provide IP networks, private lines, network management and hosting services, along with sales, installation and maintenance of major branded IT and telephony equipment.
What's Shaping the Future of the Diversified Communication Services Industry?
Persistent Demand Erosion: Efforts to offset substantial capital expenditure for upgrading network infrastructure by raising fees have reduced demand, as customers tend to switch to lower-priced alternatives. Moreover, local-line access for traditional telephony services continues to decline due to higher wireless substitution and migration to IP-based services. This is reflected in the persistent erosion in overall network access services on a year-over-year basis, hurting revenues of local and long-distance operations.
In addition, a shift toward wireless services and the aggressive rollout of VoIP and long-distance services have resulted in access line erosion. These adverse impacts have become more pronounced with the soft economic recovery in China, the prolonged Russia-Ukraine war and the Israel-Hamas conflict.
Escalated Production Costs: Although the supply chain woes have declined progressively, the industry continues to face a dearth of chips, which are the building blocks for various equipment used by telecom carriers. Moreover, high raw material prices due to inflation and economic sanctions against the Putin regime have affected the operation schedules of various firms. Extended lead times for basic components are also likely to hurt the delivery schedule and escalate production costs. The demand-supply imbalance has crippled operations and largely affected profitability due to inflated equipment prices.
Short-Term Profitability Compromised: Video and other bandwidth-intensive applications have witnessed exponential growth owing to the wide proliferation of smartphones and increased deployment of the superfast 5G technology. This has forced the industry participants to invest considerably in LTE, broadband and fiber to provide additional capacity and ramp up the Internet and wireless networks.
These companies are rapidly transforming themselves from legacy copper-based telecommunications firms to technology powerhouses with capabilities to meet the growing demand for flexible data, video, voice and IP solutions. At the same time, the industry participants continue to focus on leveraging wireline momentum, expanding media coverage, improving customer service and achieving a competitive cost structure to generate higher average revenue per user while attracting new customers. Although these infrastructure investments are likely to be beneficial in the long run, short-term profitability has largely been compromised.
Integrated Service Offering: To improve profitability, the companies are increasingly focusing on providing support services to various small and mid-sized businesses (SMBs) with an integrated portfolio of voice, data and technology services. The firms are tailoring their services to suit individual business needs and are facilitating SMBs to better adapt themselves to necessary technology advancements. The industry is battling hard-to-mitigate operating risks stemming from volatility in demand, an unpredictable business environment and challenging geopolitical scenarios by offering free services to low-income families and seamless wireless connectivity to the masses.
Zacks Industry Rank Indicates Bearish Trends
The Zacks Diversified Communication Services industry is housed within the broader Zacks Utilities sector. It carries a Zacks Industry Rank #178, which places it in the bottom 29% of more than 250 Zacks industries.
The group's Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates bleak near-term prospects. Our research shows that the top 50% of the Zacks-ranked industries outperform the bottom 50% by a factor of more than 2 to 1.
Before we present a few diversified communication stocks that are well-positioned to outperform the market based on a relatively modest earnings outlook, let's take a look at the industry's recent stock market performance and valuation picture.
Industry Lags S&P 500, Outperforms Sector
The Zacks Diversified Communication Services industry has lagged the S&P 500 composite but has outperformed the broader Zacks Utilities sector over the past year largely due to macroeconomic headwinds.
The industry has lost 1.1% over this period against the S&P 500's growth of 22.8% and the sector's decline of 8.9%.
Industry's Current Valuation
On the basis of the trailing 12-month enterprise value-to-EBITDA (EV/EBITDA), which is the most appropriate multiple for valuing telecom stocks, the industry is currently trading at 13.36X compared with the S&P 500's 14.23X. It is trading below the sector's trailing 12-month EV/EBITDA of 15.74X.
Over the past five years, the industry has traded as high as 18.45X, as low as 8.36X and at the median of 13.11X, as the chart below shows.
3 Diversified Communication Services Stocks to Bet On
Swisscom: Headquartered in Bern, Switzerland, Swisscom offers mobile and fixed-network telecommunications services across the country and Italy. A wealthy domestic market with stable economic conditions, a relatively lax regulatory environment compared to the EU, its dominant market position and a strong leadership team are some of the key growth drivers of the company.
With a complete spectrum of state-of-the-art data services, from leased lines to integrated solutions for corporate and residential customers, Swisscom's healthy growth momentum is likely to continue. The Zacks Consensus Estimate for current-year and next-year earnings has been revised upward by 19.3% and 19.6%, respectively, since January 2023. The stock carries a Zacks Rank #2 (Buy). You can see the complete list of today's Zacks #1 Rank (Strong Buy) stocks here.
PT Telekom: Headquartered in Bandung, Indonesia, PT Telekom offers mobile communication, fixed-line communication and broadcasting services worldwide. The company has collaborated with Indosat Ooredoo Hutchison, which is likely to contribute significantly toward the growth of the country's digital ecosystem and economy. This Zacks Rank #2 stock has a VGM Score of B. PT Telekom has a long-term earnings growth expectation of 12.4%.
Telefonica Brasil: Based in Sao Paulo, Brazil, Telefonica Brasil is the subsidiary of Spain-based telecom giant Telefonica SA. The company has been actively investing in technology upgrades and broadband network expansion to retain competitiveness in the rapidly changing market. Its unique value proposition, coupled with excellent customer experience, should help it register net additions in postpaid.
The Zacks Consensus Estimate for current-year earnings has been revised 25% upward over the past year. Telefonica Brasil has a long-term earnings growth expectation of 18.7%. This Zacks Rank #2 stock has gained 31% in the past year.
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