The past few months have been forgettable ones for the Dow Jones Industrial Average (INDEX: ^DJI ) , which included its worst month in two years this past month, when it lost 6%. The blue chips are still treading water, hoping to approach April's highs once again, but in that time two surprising stocks have been some of the best performers on the index. They're also the two biggest dividend payers on the Dow.
Guessed 'em? It's AT&T (NYSE: T ) and Verizon (NYSE: VZ ) , up 14.5% and 18%, respectively. The normally sleepy telecoms have bucked the market's downward trend, and they're not the only ones in the industry. The Dow Jones US Telecommunications Index is up more than10% in that time period, while the smaller Sprint Nextel (NYSE: S ) has gained 20%. While this sector in many ways bears resemblance to utilities, with high concentration, regulation, and dividend payouts, the stocks have broken the expected low volatility pattern in the last quarter. Let's take a closer look and see what's afoot in the telecom industry.
There's something happening here
AT&T jumped to post-recession highs on the strengths of its first-quarter earnings report, beating EPS estimates by more than 5% and increasing wireless data revenue by more than 19%. Though data makes up only about a fifth of revenue currently, this should be a huge growth market in coming years as Ma Bell and Verizon start capping their unlimited data plans and increasing revenue in that area as more Americans convert to smartphones.
Verizon's Q1 performance, meanwhile, was also greeted with a standing ovation from investors, as shares climbed about 7% in the week after its earnings report. The nation's leading wireless carrier reported a 16% increase in EPS, a 7.7% increase in overall service revenue, which included a 21% jump in wireless data revenue. An agreement to transfer spectrum with T-Mobile at the end of June drew much attention, though the financial terms were not disclosed. The deal includes a number of intra-market swaps that should allow both providers to expand their LTE offerings.
Along the way, AT&T and Verizon both received ratings upgrades, and the two appear to be gaining their market power by consolidating, and squeezing customers and hardware makers.
It's a game called duopoly
Telecommunications may be the most concentrated industry in the country, and don't forget that AT&T already was a monopoly once upon a time. The two heavyweights now control about 65% of the wireless market and haven't been shy about grabbing more of it. Only the FCC stood in the way of AT&T's plan last year to merge with T-Mobile, the nation's fourth-leading mobile carrier.
The average cell-phone bill has risen 52% since 2006 to nearly $100 a month, and Verizon recently made it clear that this pattern will continue with its new shared (family) data plan, which allows customers to use data for a variety of devices, such as tablets, and will come with unlimited voice and texting. It's the next step in getting customers off unlimited data plans, and this time it forces early adopters who had been allowed to keep their old unlimited plan into the tiered payment program. The shared data structure has been roundly criticized in the media as a way of further squeezing consumers, but Verizon won't be going it alone. AT&T has signaled that it has similar intentions. In a concentrated industry like this, what's bad for customers is often good for the bottom line. Both AT&T and Verizon posted operating margins above 15% in their most recent quarter.
Everybody wants that iPhone money
It's no secret that Apple (Nasdaq: AAPL ) has risen to dominance in both the stock market and the tech world on the strength of the iPhone. The pocket-sized computer brings in more than half of the Cupertino behemoth's revenue.
But Apple needs willing partners to deliver the capabilities of its smartphone, and AT&T and Verizon seem to be finally catching on to this. The shared data plans will raise prices on consumers and could delay upgrades when the iPhone 5 comes out later this year, as some users may want to keep their unlimited data. This would benefit the providers by delaying the subsidies they pay to Apple; the longer they can keep you on the same phone, the better for them, and Verizon took another step in this direction, announcing earlier this year that it will charge $30 for phone upgrades. Both providers posted higher margins on fewer iPhone sales in their last quarter, showing that Apple's been taking a big bite out of profits. In many ways, Apple needs the telecoms more than the telecoms need the iPhone-maker.
There's plenty of money to go around for everyone here, though, especially as smartphone conversion and data usage increase. Smartphones currently make up 60% to 70% of revenue for the phone companies but just 30% of subscriptions, meaning the opportunity for smartphone revenue to double or triple is ready and waiting. Between 2009 and 2014, Cisco and other groups estimate that data traffic will grow a whopping 35 times, with the bulk of that revenue going you-know-where. Additionally, the number of worldwide machine-to-machine (M2M) connections is estimated to jump from just 62 million in 2010 to 2.1 billion in 2020.
There's a movement taking place here, and while Apple and the other smartphone makers stand to benefit, AT&T and Verizon are the ones holding the cards. With a majority of the subscribers in the U.S., they have already begun exerting domination over the market, but what's amazing is that despite this position in a growing industry, Wall Street sees almost no growth ahead. The analysts are eyeing 2013 top-line increases of just 3.2% for Verizon and only 1.4% for AT&T, less than the inflation rate. I think the big boys can easily top those numbers, and even a small beat will push the stock measurably higher when such slow growth is expected. That's why I've decided to give the two a thumbs-up in CAPS. There's a lot more growth in this area than Wall Street is giving credit for.
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