3 Small Cap Plays on 5G

06/12/2019 5:00 am EST

Focus: TELECOM

Richard Moroney

Editor, Dow Theory Forecasts

Wireless carriers are racing to build 5G networks, the next generation of cellular connections. 5G promises faster speeds for consumers and better efficiency for network operators, suggests Richard Moroney, editor of the small cap focused advisory service, Upside Stocks.

Full-length movies will take just seconds to download, compared to five or six minutes on current 4G networks. 5G will use less power, preserving devices’ battery life. And it could pave the path toward self-driving cars and other new businesses that revolve around remotely accessing massive amounts of data.

Both AT&T (T) and Verizon (VZ) are rolling out 5G networks to a handful of U.S. cities in 2019, though widespread service may not be available for a couple years.

Four of the five largest smartphone makers are expected to introduce 5G devices this year, while a 5G-powered iPhone from Apple (AAPL) is unlikely before 2020.

These network upgrades promise to be capital-intensive projects, creating multiyear opportunities for networkequipment makers, semiconductor companies, contractors, and others involved with the production of 5G components.

More complex than prior networks, 5G will employ a lacework of connection points that involve both traditional cell towers and small cells. Three top picks with meaningful 5G exposur. are reviewed below.

Semiconductor company Diodes (DIOD) figures to gain new business as wireless carriers roll out their 5G networks. Diodes has already secured design wins for several 5G applications, such as those in base stations, data centers, and small cells — radio equipment and antennas placed on streetlights and utility poles.

Momentum in 5G has failed to translate to a strong performance for Diodes shares, down 23% in the past three months. The weakness seems to reflect general trade-war jitters rippling through the semiconductor industry rather than anything specific to Diodes.

No customer accounts for more than 10% of Diodes’ revenue, limiting any fallout from the U.S. ban on China’s Huawei, a maker of smartphones and networking gear.

Aside from Performance, the stock scores above 80 for all other Quadrix categories, contributing to an Overall rank of 99. Diodes has delivered eight straight quarters of double-digit sales growth, and management’s Junequarter guidance impressed analysts.

The stock trades at 12 times trailing earnings and 11 times estimated 2019 profits — both more than 25% below the medians for semiconductor stocks in the S&P 1500 Index. Diodes is rated Best Buy.

Generac (GNRC) is a key supplier of backup-power systems for all of the major U.S. wireless carriers. These backup-power systems are crucial for Generac’s customers to provide uninterrupted service for connecting everything from smartphones to cars to their networks.

Management sees an extended cycle of investment from the 5G upgrade that began in the second half of 2018, accelerated in the March quarter, and could last another couple years. Residential-power generators are Generac’s biggest product, accounting for slightly more than half of its sales growth. That business remains strong, growing 14% in the March quarter and 20% in 2018.

Generac’s distribution network, at least three times bigger than its closest rival, provides a key competitive advantage. In May, Generac raised its 2019 sales guidance to 5% to 9%, versus its prior target of 3% to 7%. Products imported from China will be saddled with higher costs after June 1, though Generac has been building its inventories in anticipation of the tariffs. T

he shares trade at 12 times estimated 2019 earnings, well below the median of 16 for the S&P 1500 Index industrials sector. At less than 12 times trailing earnings, the stock trades near its lowest level in a decade. In Quadrix, Generac earns scores of 70 for both Value and Momentum. Generac is a Best Buy.

Billing itself as the largest wireless contractor in North America, MasTec (MTZ) is behind the engineering and construction of the 5G networks. With 5G still in its early stages, management says the upgrade will be a significantly bigger opportunity for MasTec than it had first thought.

As with the prior network rollouts, MasTec will be modifying cell towers, changing antennas, and putting in new lines. But 5G involves a denser web of touchpoints — light poles and utility poles will be outfitted with cellular equipment to help handle the higher data loads.

AT&T is MasTec’s biggest customer, accounting for 23% of sales last year. MasTec is expanding its staff and investing in new equipment, moves likely to pressure 2019 profit margins. Still, per-share profits are projected to climb 21% this year on 11% revenue growth.

Management says the bulk of the 5G activity won’t begin until 2020. With that in mind, analyst estimates for 2020 seem conservative, given the consensus currently targets 12% profit growth on 6% higher sales.

MasTec shares trade at just 10 times estimated 2019 earnings and nine times projected 2020 profits — more than 15% discounts to the medians for construction and engineering stocks in the S&P 1500 Index. MasTec, earning an Overall score of 99, is rated Buy.

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