Telcos Ring Up Low Prices, High Yields

09/19/2007 12:00 am EST

Focus: STOCKS

Neil George

Editor-in-Chief, Income Publication and Products, Agora Financial

Neil George and Roger Conrad, editors of Personal Finance and the Utility Forecaster, think rural telecom companies have strong businesses and are selling at rock-bottom prices.

If you didn’t get in on rural phones the last time they were cheap, [the stocks in our portfolio are] ringing again. The group has suffered greatly this summer and now yields an eye-catching average of 9%. This year’s posting certainly had nothing to do with group fundamentals, which remain solid.

Rural telecoms continue to post rising revenue and cash flow because they’re getting more money than ever per customer by upselling services like broadband and wireless. The game isn’t about keeping as many of their worst customers as possible. It’s about expanding the rolls of their best, thereby boosting profitability, cash flow, and ability to pay distributions.

Citizens Communications (NYSE: CZN) posted 14% higher revenue on 17% growth in its data and Internet business. It also added to its rolls of basic customers with an acquisition, giving it more opportunities to upsell.

Consolidated Communications (NASDAQ: CNSL) boosted its Internet Protocol television service’s customer rolls by 14.5%, increasing revenue as it neared a fourth-quarter close on a Pennsylvania phone system. FairPoint Communications’ (NYSE: FRP) purchase of Verizon Communications’ rural phone lines in Maine, New Hampshire, and Vermont punished the stock, largely on misplaced concerns about the merger’s execution. But with the bulked-up cash-generating assets, dividends should climb with a rise in distributable cash flows from the deal.

The volatility in Iowa Telecom (NYSE: IWA) and Otelco (AMEX: OTT) is the most mystifying of the group. On the fundamentals side, both posted strong second-quarter sales and cash flows, and show every sign of continuing to do so the rest of the year and well beyond.

IWA’s second-quarter revenue, for example, rose nearly 10% from last year’s level and reaffirmed 2007 full-year guidance. Otelco slashed debt 16% and boosted broadband users to 33% of its base in Alabama and Missouri. Traders have seemed to take advantage of their low trading volume and more timid income investors’ tendency to sell when something goes down dramatically without bothering to find out why.

But it’s all background noise. As long as these businesses remain steady performers, the stocks will eventually rebound. And they’ll keep paying those big dividends along the way. Another heartening fact to keep in mind: the US government continues to support them with subsidies from the Universal Service Fund and the Broadband Initiative Program administered by the Rural Development Division of the US Department of Agriculture.

When they’re cheap like this, they’re even more of a takeover target in a rapidly consolidating industry. Their depreciable assets give them the ability to avoid most taxes. And cash flows cover distributions by healthy margins.

Buy CZN up to $16, CNSL up to $24, FRP up to $22, IWA up to $25 and OTT up to $27. (All closed well below those target prices Tuesday—Editor.)

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