European Stocks Head for Best Gain in a Decade. Then There’s Telecoms

(Bloomberg) -- It took a few encouraging statements on both sides of the Pacific to finally get the breakthrough the European market was waiting for. The Stoxx 600 has finally pierced above a long-standing resistance area, and is on track for its best year since 2009. But not everyone is benefiting, with three industries left behind: oil & gas, banks and telecoms. With value stocks’ underperformance now reversing and equity flows coming back, investors may start looking at these forgotten stocks. Telecoms, a non-cyclical value sector, offer some interesting features.

For a group that’s perennially down in the dumps, European telecoms have made something of a comeback since mid-August with an 11% rally. They’re on track to close 2019 in positive territory, which would mark their first annual gain in four years. But there’s some distance to recover as the sector has erased about 180 billion euros ($200 billion) of market value since August 2015.

Outside of the typical value call, there is also the prospect of telecom stocks benefiting from a potential slowdown of the global economy.

“If people think there’s going to be a recession, then they’re not really going to want to buy banks and cyclicals, because they’ll think they’ll get worse, so telecoms really stand out in that scenario,” says Alasdair McKinnon, lead manager of the Scottish Investment Trust. McKinnon added to his holdings in telecoms around February/March. His underlying thesis is that telecoms stocks are cheap and have been out of favor for a long time.

That’s not all. There seems to be some value within the sector’s fixed assets. Analysts at JPMorgan said in a recent note that the “explosion” in infrastructure valuations offers a “ray of hope” for the sector. The analysts see Vodafone and Orange Belgium as the main stocks able to “unlock substantial upside” in monetizing their tower networks, while Telefonica, Telefonica Deutschland and Telecom Italia would be smaller beneficiaries.

They also see Cellnex as an attractive play on the tower theme. Indeed, Cellnex is the second-best performer in the SXKP with a 92% surge this year as the Spanish towers firm snapped up assets from Iliad, Salt Mobile, Cignal Infrastructure and Arqiva. Cellnex is also selling new shares in order to fund more deals. Still, the valuation gap with larger telcos has become abysmal.

Outside of fixed assets, the “value” feature of telecoms is difficult to assess. On the one hand, the sector now trades pretty much with the broader Stoxx Europe 600 index on an estimated price-to-earnings of 15.5, which is also in-line with the 10-year average. On the other hand, it stills carries a dividend yield of 4.9%, surpassing the market’s 3.5%.

However, it’s a double-edged sword. Bank of America strategists recently double downgraded European telecoms to underweight as they worry that a rise in bond yields over the coming months could be a drag on the sector, as telecoms are often considered bond proxies.

We’ve already seen Vodafone cut its dividend back in May, after pressure from falling revenue, and costly outlays for acquiring spectrum finally took its toll. BT, which reported broadly well-received results last week, has seen the sustainability of its dividend called into question as the U.K. looks to roll-out faster fiber-optic broadband by 2025, an expensive prospect for the phone company.

In the end, there remains the ever-present issue that telecom companies are still struggling, while regulation keeps any M&A activity muted as price wars rage across Europe, so there is still a long way to go. After Telefonica met estimates and confirmed its 2019 guidance and dividend today, all eyes are on Deutsche Telekom and Telecom Italia earnings on Thursday.

To contact the reporters on this story: Michael Msika in London at mmsika4@bloomberg.net;Kit Rees in London at krees1@bloomberg.net

To contact the editors responsible for this story: Blaise Robinson at brobinson58@bloomberg.net, Jon Menon, Namitha Jagadeesh

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