A Rare Chance To Lock In A 7% Yield From This Best-In-Class Telecom

At this point, I don’t think anyone needs convincing that the world is glued to the phone. Yet, these hand-held computers aren’t much more useful than a paperweight without wireless service. There are now 310 million smartphone users in the United States, one for nearly each of the 331 million citizens. And for most, that cell phone bill must be paid every 30 days.

All those unlimited data plans equal a steady source of recurring revenue. On the downside, market saturation has limited growth opportunities. Capital spending requirements are also immense (building a nationwide 5G network isn’t cheap). Fortunately, those expenses also act as a natural barrier to entry. This lucrative market has become a tight oligopoly between that and natural consolidation.

Thanks to their size and scale, the incumbent leaders can spread fixed expenses over a larger base, minimizing costs per subscriber and undercutting would-be rivals with thinner margins. That economic advantage leads to more subscribers, thereby widening the lead. It’s the same virtuous cycle that TCI founder John Malone used to become a kingpin in the media world.

Translation: the strong get stronger.

My Top Telecom Pick

Verizon doesn’t need much introduction, particularly if you own one of the 115 million phones, laptops, smart watches, or other devices tethered to its vast network. Aside from consumers, the company also caters to 99% of the Fortune 500 and has 29 million wireless connections on the business/enterprise side — for a total of 144 million.

Verizon’s 4G LTE blankets 99% of the U.S. population. Just a few years ago, it was cutting-edge telecom architecture. But the future belongs to the firm’s next-gen 5G ultra-wideband network, which facilitates blistering download speeds (up to 100 times faster than 4G) and now reaches 200 million people nationwide. While each major carrier makes bold claims, Verizon’s trophy case holds dozens of J.D. Power awards for Network Quality.

Meanwhile, the company has aggressively rolled out its Fios broadband internet service to homes and businesses from the Mid-Atlantic states through New England. The advanced fiber optic network supports bundled TV and internet, a potent weapon in the war against cable rivals. With over 1 million miles of fiber optic cables and affordable packages starting at just $25 monthly, Verizon has made 8.2 million broadband internet connections.

Of course, unit volume is only part of the equation. Pricing is just as important. Average revenues per account (ARPA) in the wireless postpaid segment just hit $152 per quarter. That’s an increase of 5% from a year ago. In turn, total wireless service revenues (not counting broadband) are now approaching $20 billion per quarter.

What’s Weighing On The Stock?

This summer, the telecom sector was rocked following the publication of a troubling Wall Street Journal story exposing potential fallout from lead-sheathed cables.

A century ago, lead was commonly used in countless industrial applications. But lead-clad copper cables haven’t been manufactured in over half a century. Phase-outs began 73 years ago; the last installations were made in the 1960s. Many of these cables are no longer in service and have been abandoned. Considering their deployment predates the famous breakup of Ma Bell into the seven regional Baby Bells back in 1984, ownership records might be spotty.

Nobody is entirely sure how many such cables are still in place. By all indications, telecom companies were in full compliance with existing laws. But that won’t stop overzealous regulators from seeking damages today.

To say this sudden development arose unexpectedly would be an understatement. Analysts who have covered this industry for years never saw it coming. The Environmental Protection Agency (EPA) has never rung any alarm bells. The Wall Street Journal consulted four former Federal Communications Commission (FCC) commissioners — not one was even aware of lead in telecom networks.

Whatever happens, most agree on this: AT&T (NYSE: T) will shoulder the heaviest burden. With a vast network of legacy long-distance lines and local exchange carrier (LEC) assets, it bears the most risk. By contrast, Verizon has always been far more focused on building out its wireless network. Still, the company isn’t entirely out of the woods.

Rest assured, I’ll be closely monitoring this situation. But for now, I agree with Morningstar that the risks are likely overblown and liability limited. If I’m right (again, I’m not the only one who thinks this), then that presents a unique opportunity.

The Dividend (And Looking Ahead)

Verizon spends freely to maintain its competitive edge. But plenty of excess capital is available to investors.

With a quarterly dividend of $0.66 per share, distributions consumed a little over half of last quarter’s net profit. Incidentally, that payout has risen for 16 straight years. That best-in-class streak has kicked the yield up to 7.4% — nearly five times the S&P 500 average.

Growth rates will likely remain modest (low single digits) in this mature industry. But Verizon is gaining some traction in the broadband arena. And 60% of its wireless phone users now have 5G capable devices, which should spur more data consumption. Management has also made some savvy partnerships, teaming up with Apple for music streaming and collaborating with Disney for bundled sports and entertainment content.

Better still, the era of peak spending on spectrum and equipment is over for now. After dishing out $23 billion last year, capex is expected to moderate to $19 billion this year and drop to $17 billion in 2024. That’s an extra $4 billion to $6 billion in free cash flow.

Closing Thoughts

With irreplaceable assets, high barriers to entry, and lofty returns on invested capital (RoIC) in the upper teens, this wide-moat business is the textbook example of a Forever stock. And thanks to overblown fears, this industry leader is now trading at less than 4 times cash flows.

Patient investors should take a look at this best-in-class telecom and lock in this high yield while they can.

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