MoffettNathanson 'decidedly bearish' on telcos despite hopeful second quarter

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Investors should be wary of betting on wireless in the long term, MoffettNathanson said.

The wireless industry “is still a secularly unappealing one,” according to MoffettNathanson, despite an unexpectedly positive second quarter. But that doesn’t mean investors should flee the market quite yet.

All four major U.S. wireless carriers reported positive postpaid smartphone net additions during the most recent quarter, and all posted unexpectedly low churn. But those earnings—and the resulting optimism—appear to have been the result of lowered expectations rather than any real momentum, Craig Moffett wrote in a note to investors.

“Almost as quickly as it started, the short-lived telecom rally of midsummer already seems to be fading,” according to Moffett. “Second-quarter earnings reports were initially greeted with relief, and for a hot minute the telecom sector seemed to have gotten its mojo back. But, in retrospect, the market’s reaction to Q2 results said more about how low expectations had gotten than it did about any real improvement in fundamentals. Industry growth metrics in Q2, it should be noted, were in fact the worst the industry has ever seen. Now, whatever meager enthusiasm there was for the sector has seemingly already faded.”

Competition “remains relatively muted,” Moffett continued, despite T-Mobile’s new offer to foot the bill for its customers’ Netflix subscriptions. But revenue growth has stalled, balance sheets are “still badly overstretched,” returns on capex investments are lackluster and the possibility of consolidation is still far from clear.

Meanwhile, competition is sure to ramp up significantly during the coming holiday season, which will see the release of high-end smartphones from powerhouses such as Apple and Google. Carriers are sure to launch aggressive promotions in the hopes of leveraging those devices. While those moves could help them increase market share, they could also take a financial toll.

“So, is our neutral stance on the sector still warranted? And what of our buy rating on Verizon?” Moffett asked. “Our view is yes, for both questions… but only narrowly so. The industry is still a secularly unappealing one, and our longer-term bias is still decidedly bearish. For now, however, valuations and expectations are low enough that it makes sense to stay the course. Just don’t stay the course too long.”