The Zacks Diversified Communication Services industry is poised to benefit from healthy demand trends led by increased fiber densification and accelerated 5G deployment worldwide. However, high capital expenditures for infrastructure upgrades, unpredictable raw material prices, geopolitical conflicts and elevated inventory levels amid a challenging macroeconomic environment and uncertain market conditions have dented the industry’s profitability.  

Nevertheless, Deutsche Telekom AG DTEGY, Telefonica, S.A. TEF and Shenandoah Telecommunications Company SHEN will likely benefit in the long run from the wide proliferation of IoT and transition to cloud networks and next-gen technologies driven by higher demand for scalable infrastructure for seamless connectivity.

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?

Integrated Service Bouquet: The companies are focusing on providing support services to various small and mid-sized businesses (SMBs) with an integrated portfolio of voice, data and technology services to improve margins and business sustainability. The firms are tailoring their offerings to suit individual business needs and are facilitating SMBs to better adapt themselves to necessary technology advancements.

Short-Term Profitability at Stake: Video and other bandwidth-intensive applications have witnessed exponential growth owing to the vast proliferation of smartphones and increased deployment of the superfast 5G technology. This has forced industry participants to invest considerably in LTE (Long-Term Evolution), broadband and fiber to provide additional capacity and ramp up the Internet and wireless networks. Although these infrastructure investments are likely to be beneficial in the long run, short-term profitability has been compromised. High raw material prices due to elevated inventory levels, economic sanctions against the Putin regime and intensifying war-mongering conditions in the Middle East have further affected the operation schedules of various firms. 

Focus on Low Latency, High Bandwidth Applications: Industry participants are rapidly transforming themselves from legacy copper-based telecommunications firms to technology powerhouses. At the same time, the firms 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. Also, these firms offer the flexibility to better manage data traffic by leveraging indigenous software-defined networks to enable low-latency, high-bandwidth applications for faster access to data processing. In addition, the industry participants are focusing on other revenue-generating opportunities in adjacent verticals such as consumer goods, precision agronomy, animal agriculture and the digital health services market to optimize production capabilities through access to data and key insights.

Zacks Industry Rank Indicates Bullish Prospects

The Zacks Diversified Communication Services industry is housed within the broader Zacks Utilities sector. It carries a Zacks Industry Rank #82, which places it in the top 33% of more than 250 Zacks industries.

The group’s Zacks Industry Rank, which is the average of the Zacks Rank of all the member stocks, indicates bright 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 two to one. 

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, Sector

The Zacks Diversified Communication Services industry has lagged the S&P 500 composite and the broader Zacks Utilities sector over the past year due to macroeconomic headwinds.

The industry has declined 11.7% over this period against the S&P 500’s and the sector’s growth of 8.8% and 14.9%, respectively.

One-Year Price Performance

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 11.67X compared with the S&P 500’s 16.75X. It is also trading below the sector’s trailing 12-month EV/EBITDA of 16.31X.

Over the past five years, the industry has traded as high as 21.47X and as low as 8.73X, with a median of 12.54X, as the chart below shows.

Trailing 12-Month enterprise value-to EBITDA (EV/EBITDA) Ratio

3 Diversified Communication Services Stocks to Watch

Deutsche Telekom: Headquartered in Bonn, Germany, Deutsche Telekom is one of the largest telecommunications service providers in Europe. In addition to its strong position in the domestic market, the company is poised to benefit from the accretive post-merger integration of T-Mobile US Inc. and Sprite in the United States, in which it owns about 43% stake. The removal of forced cable TV access in multiple dwelling units in Germany through telecom legislation is likely to help the company expand its broadband market. Moreover, an aggressive fiber rollout strategy across the country is expected to augment its domestic market hold. It has a long-term earnings growth expectation of 11.3%. It has a VGM Score of B. The stock has gained 51.6% in the past year. The Zacks Consensus Estimate for current-year earnings has been revised upward by 18.5% to $2.31 per share since April 2024. Deutsche Telekom sports a Zacks Rank #1 (Strong Buy). You can see the complete list of today’s Zacks #1 Rank stocks here.

Price and Consensus: DTEGY

Telefonica: Based in Madrid, Spain, Telefonica provides mobile and fixed communication services in Europe and Latin America. In recent years, the company has invested heavily in the deployment and transformation of its network to provide excellent connectivity in terms of capacity, speed, coverage and security. The rollout of fiber and LTE is set to drive considerable growth. The company has launched 5G+ (5G SA) in Spain, Brazil, Germany and the U.K. and plans to increase the 5G SA coverage in core markets by 2025. The stock has gained 8.4% in the past year. The Zacks Consensus Estimate for current-year earnings has been revised upward by 3.1% since April 2024. This Zacks Rank #2 (Buy) stock has a VGM Score of B. The company delivered a trailing four-quarter earnings surprise of 23.9%, on average.  

Price and Consensus: TEF

Shenandoah Telecommunications: Based in Edinburg, VA, Shenandoah Telecommunications provides various broadband communication services and cell tower colocation space in the Mid-Atlantic portion of the United States. It offers high-speed, state-of-the-art fiber optic network, broadband Internet, video, voice, high-speed Ethernet, dark fiber leasing and managed network services. The company owns an extensive regional network with over 16,800 route miles of fiber. Shenandoah Telecommunications carries a Zacks Rank #2.

Price and Consensus: SHEN

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This article originally published on Zacks Investment Research (zacks.com).

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