Wednesday, April 25, 2007
Telecom is back.
While the rest of the investing world focuses on the housing bubble, interest rates, and Iran, the telecom sector has quietly been proving itself to be one of the best investments of the last nine months.
Starting in July of last year, the U.S. telecom ETF has soared. It's nearly doubled the performance of the S&P 500. Verizon (VZ) is up 22%, and AT&T (T) has rallied nearly 50%. Sprint Nextel (S) has rallied 20% but is breakeven for the period due to weak earnings in early August 2006.
What's going on here is simple... sectors that become immensely overvalued usually require seven to 10 years to disgust investors and become bargains again. And telecoms have been plenty disgusting since the tech bubble burst in 2001. All three of the telecom majors are down between 30% and 60% from their tech-bubble highs.
But it's beginning to change.
The massive debts incurred during the fiber-optics expansion from 1998 to 2001 have been written off. The new technology (high speed internet, cell phones) is now widely accepted. And the industry as a whole has completed a strong period of consolidation (SBC bought AT&T, Sprint bought Nextel, Verizon bought MCI).
Simply put, the U.S. telecom industry has stabilized and grown in profitability in the last two years. Today, AT&T and Verizon are producing free cash flow of $7 billion a year. Even Sprint is producing $5 billion.
It's hard to believe, but nowadays these companies are actually value plays. All three are now throwing off more free cash than they were during the tech bubble.
Verizon is generating enough free cash flow that it could take itself private. Sprint Nextel is trading well below its five-year average for its price-to-cash flow multiple. AT&T's 2006 earnings are on par with its tech-bubble levels. Yet the company's share price is 30% cheaper than in 2001.
Even at today's levels, these companies are still relatively cheap. So cheap that the world's best value investors have begun piling into the sector.
The irony of seeing Mason Hawkins and David Dreman buying telecom stocks is almost overwhelming. Hawkins manages the Longleaf family of mutual funds. Over the last 10 years, he's shown investors average annual gains of 12%, trouncing the 8% gains of the S&P 500 for the same time period. He's a value investor to the core. The same can be said of Dreman, whose Large Cap Value Fund has shown investors average annual gains of 17% since 1991.
Ten years ago, these guys wouldn't have touched a telecom company with a 10-foot pole. Yet today, they're buying large-cap telecom stocks with hundreds of millions of dollars.
That's contrarian investing at its finest.
Oil & gas pipelines continue an amazing run... Buckeye Partners, Enbridge Energy Partners, Magellan Midstream, TC Pipelines, Teppco, and Williams Companies reach yearly highs.
Shipping still booming: DryShips, Omega Navigation, and Quintana Maritime at yearly highs.
Infrastructure and building plays continue to lead the market. New highs for Kennametal (cutting tools), Terex (heavy equipment), Cummins (diesel engines), and AK Steel (steel).