Domestic telecom spending has been pretty anemic over the last several quarters, as the nation’s largest carriers have tightened their belts in the wake of the deep recession and global financial crisis. But infrastructure investment, from routine maintenance work to new fiber-network deployments, finally looks to be recovering at a moderate pace, aided by an improving economic backdrop. (The U.S. economy expanded at a 2% annual rate in the third period of 2010.) This should benefit one of our favorite names in the telecommunications services space, Dycom Industries (DY).
The Palm Beach Gardens, Florida-based outfit is a leading provider of engineering, construction, installation, and maintenance services to the telecommunications, cable television, and utility markets. And it has managed to piece together a pretty impressive client roster since being incorporated way back in 1969. Indeed, the specialty contractor’s top five customers, accounting for more than 60% of the revenue mix, include AT&T (T - Free Analyst Report), Verizon (VZ - Free Analyst Report), CenturyLink (CTL), Comcast (CMCSA), and Time Warner Cable (TWC). This means that Dycom’s fortunes, for better or worse, are closely tied to the capital spending habits of our nation’s largest carriers.
The correlation has mostly been a blessing for the company since the Internet revolution of the 1990s. The Telecommunications Act of 1996, in particular, was a watershed moment for Dycom and its rivals, like MasTec (MTZ) and Quanta Services (PWR). (Notably, Dycom’s annual revenues approximated just $150 million in the mid-1990s, compared with around $1 billion today.) That sweeping legislation gave long-distance carriers, local telephone companies, cable operators, and public utilities free rein to enter each other’s markets. And it ushered in a new ultra-competitive era, one in which communications providers of every stripe sought to upgrade their networks to fiber (typically from copper wire or coaxial cable) and bring the “information superhighway”, including new high-bandwidth services (e.g., video, wireless data, Voice over Internet Protocol, etc.), to individual homes and businesses.
The upgrade cycle in the telecom market, while threatened by the bursting of the technology bubble in 2000, continued through the first decade of this century, albeit at a somewhat uneven and sometimes sluggish pace. It seemed to come to an abrupt end during the difficult 2008-2009 time frame, however, when the financial meltdown and freezing of the credit markets prompted many carriers to delay new capital spending projects and hoard cash. This turn of events took a heavy toll on Dycom’s financial performance. (Share earnings of just $0.17 for fiscal 2010, which ended July 31st, marked the company’s lowest bottom-line tally in more than fifteen years.) And it caused many industry watchers to wonder if the lengthy telecom spending spree was over.
Today, it’s looking more likely that the recent infrastructure investment freeze was just a short-lived pause, and that another upgrade cycle is beginning. In fact, in North America, capital spending by large carriers like AT&T and Verizon will probably rise about 2% this year, to around $57 billion, after a near-10% decline in 2009. And the momentum should build further in 2011, as sector heavyweights from the telecom and cable end markets rush to shore up overburdened wireless networks and roll out new mobile broadband services for Apple’s (AAPL) iPhone 4 and a host of smartphones powered by Google’s (GOOG) Android operating system.
The moderate spending uptick ought to come as very good news to Dycom, which struggles to leverage its large base of fixed overhead costs, especially labor and equipment expenses, when contract revenues slip. In the meantime, the company ought to get a lift from accretive acquisitions and the growing trend in the telecom industry toward outsourcing, which, as opposed to doing work in-house, enables carriers to operate more efficiently and with greater financial flexibility.
Dycom, with its conservative management team, good cash flow, and sound balance sheet, has a solid track record of making deals that enhance its scope of services, expand its geographic reach, and diversify its customer base. Moreover, the firm, capitalizing on the disruptive shakeout within the fragmented contracting services industry, has done a good job stealing market share from its smaller, regional competitors, many of which have fallen by the wayside or been forced into bankruptcy. This trend will likely persist well into the future, too, as the top carriers endeavor to consolidate their key vendor relationships.
All in all, we think that Dycom is an excellent way for patient, buy-and-hold investors to play the likely rebound in telecom spending over the next few years. While not overly attractive on a P/E basis at present, the stock appears inexpensive relative to the company’s sales and formidable earning power. At the very least, it’s worth putting on your watch list.
At the time of this article’s writing, the author did not have positions in any of the companies mentioned.