The Zacks Diversified Communication Services industry appears well poised to benefit from increased fiber densification and a faster pace of 5G rollout. However, high capital expenditures for 5G infrastructure upgrades, unpredictable raw material prices, inflated equipment costs, high inflationary pressures and elevated inventory levels amid a challenging macroeconomic environment and uncertain market conditions have dented the industry’s profitability.

Nevertheless, Swisscom AG (SCMWY Quick QuoteSCMWY - Free Report) , Deutsche Telekom AG (DTEGY Quick QuoteDTEGY - Free Report) and Telefónica, S.A. (TEF Quick QuoteTEF - Free Report) should benefit in the long run from higher demand for scalable infrastructure for seamless connectivity amid the wide proliferation of IoT driven by an accelerated 5G deployment.

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?

Focus on Low Latency, High-Bandwidth Applications: 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. 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. Although these infrastructure investments are likely to be beneficial in the long run, short-term profitability has largely been compromised.

Inflated Equipment and Raw Material Prices: 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 schedule 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.

Integrated Customized Offering to Beat Margin Blues: Efforts to offset substantial capital expenditure for upgrading network infrastructure by raising fees have reduced demand, as customers prefer to switch to lower-priced alternatives. Moreover, local-line access for traditional telephony services continues to decline among large customers 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. 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. At the same time, 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 Bullish Trends

The Zacks Diversified Communication Services industry is housed within the broader Zacks Utilities sector. It carries a Zacks Industry Rank #47, which places it in the top 19% 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 encouraging 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. The industry’s positioning in the top 50% of the Zacks-ranked industries is a result of a positive earnings outlook for the constituent companies in aggregate.

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 outperformed the broader Zacks Utilities sector over the past year owing to macroeconomic headwinds.

The industry has lost 13.1% over this period against the S&P 500’s gain of 2.8% and the sector’s decline of 13.8%.

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 16.44X compared with the S&P 500’s 12.55X. It is trading below the sector’s trailing 12-month EV/EBITDA of 19.96X.

Over the past five years, the industry has traded as high as 18.49X and as low as 8.59X and at the median of 14.02X, as the chart below shows.

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

3 Diversified Communication Services Stocks to Keep an Eye 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, a 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 21.2% and 15.4%, respectively, since May 2022. This Zacks Rank #2 (Buy) stock has gained 7.7% in the past year.

Price and Consensus: SCMWY

Deutsche Telekom: Headquartered in Bonn, Germany, Deutsche Telecom is one of the largest telecommunications service providers in Europe. In addition to its strong position in the domestic market, the company is likely 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. The Zacks Consensus Estimate for current-year earnings has been revised 28.1% upward over the past year. It has a VGM Score of B and a long-term earnings growth expectation of 15.7%. The stock has gained 14.9% in the past year. Deutsche Telecom 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

Telefónica: Based in Madrid, Spain, Telefonica provides mobile and fixed communication services in Europe and Latin America. In recent years, it has invested heavily in the deployment and transformation of its network to provide excellent connectivity in terms of capacity, speed, coverage and security. Telefonica has restructured its Latin American business while remaining focused on other key European markets and the United States. With a major upheaval in eight Latin American markets, the company aims to “reinvent” itself amid a challenging macroeconomic environment. The Zacks Consensus Estimate for current-year earnings has been revised upward by 34.6% since March 2023. The stock carries a Zacks Rank #2 and has a VGM Score of A.

Price and Consensus: TEF