Despite having only four major players, the United States' telecom market is fiercely competitive. Both T-Mobile (TMUS 1.03%) and Sprint (S) have taken actions to disrupt the favorable economics enjoyed by larger carriers Verizon Communications (VZ 0.80%) and AT&T (T -0.14%) in an effort to win more subscribers. T-Mobile's efforts have paid off handsomely, adding over 1 million postpaid subscribers in each of the last 19 quarters. Unfortunately, the same can't be said about Sprint's efforts. Verizon has managed to hold onto more of its higher-value postpaid phone customers than AT&T during that time, especially since introducing its new unlimited plan at the beginning of last year.
Meanwhile, cell tower companies have greatly benefited from the boom in wireless data usage. As the wireless providers continue to build out their 4G networks and prepare for 5G, American Tower (AMT 2.46%) and Crown Castle International are winning lots of new contracts for existing and new towers.
There are lots of options for investing in telecom stocks, but these are the three top telecom stocks to buy now.
The stalwart carrier
Verizon is the leader in the wireless space, with over 115 million retail connections on its network. That kind of scale provides a significant moat against the competition. In fact, T-Mobile CFO Braxton Carter has said his company's biggest disadvantage is scale.
Verizon's scale protects it from new entrants. There are substantial upfront costs to building out a wireless network, as well as barriers in acquiring the necessary radio spectrum for transmitting wireless data (not to mention regulatory hurdles). The threat of new entries for Verizon (or any of the major telecom giants) is relatively small.
But Verizon's massive size also produces much better margins than its competitors do. Last quarter, Verizon's wireless business produced an EBITDA margin of 46.2%. By comparison, T-Mobile and Sprint produced adjusted EBITDA margins of 37% and 38.6%, respectively. Even when they tweak the numbers in their favor, they can't compete with Verizon.
Verizon is also starting to move in the right direction with regard to postpaid phone customers and service revenue growth. Since introducing its unlimited data plan, Verizon has added 741,000 postpaid phone subscribers in the first 7.5 months.
The strong subscriber growth has led to a turnaround in its service revenue, which had been consistently falling for 11 straight quarters. In the third quarter of 2017, however, service revenue ticked up 1.4% sequentially, and management expects continued improvement in the fourth quarter.
One of the most attractive features of Verizon stock is its dividend, which yields around 4.5% as of this writing. Management has raised the dividend 11 consecutive years, and its substantial free cash flow ought to support continued annual raises for many years to come.
The irreverent growth machine
There's only one company out of the four major carriers that's produced meaningful service revenue growth over the last few years: T-Mobile. The Un-carrier, as it likes to call itself, has added millions of new subscribers since it started leading the industry in offering more customer-friendly service features such as unsubsidized phones and unlimited data.
T-Mobile added over 4 million new postpaid customers in 2016 and 3.6 million last year. It's added over 1 million total new customers for 19 straight quarters.
And the company isn't yet done adding new customers. It made a big geographic expansion last year, which management expects to pay significant dividends in 2018. It's currently underpenetrated in about one-third of the country compared to its more established markets. Additionally, management sees a big opportunity to bring on more enterprise customers where it has a single-digit market share.
And while T-Mobile has put its nose to the grindstone over the past five years in an effort to win more customers, that growth is finally starting to translate into more earnings and cash flow. Management expects free cash flow to grow at an average rate of 45% to 48% between 2016 and 2019, resulting in around $4.5 billion in free cash flow in the final year of the outlook. The metric increased 59% in the third quarter.
T-Mobile has started returning some of its excess cash flow to investors in the form of share buybacks. It announced a $1.5 billion authorization good through 2018, and it immediately spent nearly one-third of that cash buying back shares in December. Investors should expect management to increase the authorization before the end of the year.
The guy selling shovels in the data gold rush
With the reintroduction of unlimited data plans over the past year or so, wireless data consumption has grown to an all-time high. The average smartphone owner in North America used 37% more data in 2017 compared to 2016, according to Ericsson. It expects data consumption to continue to grow at that rate through 2023.
As subscribers consume more data, wireless providers are forced to improve their networks. And the guys selling the infrastructure (i.e., cell towers) stand to benefit. American Tower is one of the best tower companies situated to take advantage of the growth in mobile data consumption both in North America as well as around the world (where overall mobile data usage is growing even faster).
American Tower operates as a real estate investment trust (REIT), and in real estate everyone knows it's all about location, location, location. American Tower's structures are located in suburban and rural areas. That insulates the company from the threat of small cells, which are much better suited for dense urban environments. They also provide some of the best sites to deploy the 600 MHz spectrum that T-Mobile and AT&T recently acquired.
Aside from its locations, American Tower also benefits from long-term contracts with built-in price ramps, high switching costs for the carriers it services, and a business model that signs customers first before building new towers, making them profitable before they start.
American Tower produces operating leverage by deploying multiple carriers' equipment on each of its towers. As such, the risk of industry consolidation looms over the company, but its diversification outside of the United States is plenty strong to weather that possibility. Overall, it presents an interesting opportunity for investors to capitalize on the secular growth of mobile data consumption around the world.
Something for everyone
For investors looking for a nice dividend stock with strong potential for continued annual raises, a growth company that's just starting to turn its subscriber growth into real profit growth, or something in between benefiting from the secular megatrend of growing mobile data consumption, there's something in the telecom space for everyone. The three stocks detailed above are some of the best buys now in an ultra-competitive industry.