January 22, 2013 - Get Ready for Telecom Earnings
Over the past five years, mobile technology has made major advancements, literally putting the world in the palm of our hands. The convenience of mobile technology has transformed the way we view the world, but that convenience comes at a cost.
Each month we dish out a good deal of money for our mobile devices and as a result telecom companies have become lush with cash. While no one likes paying huge monthly bills for our mobile devices, for investors who hold shares in the companies the payday comes in the form of sizable dividends, which in many cases easily dwarf those in the the rest of the market.
Take for example the nation's largest mobile providers Verizon (VZ) and AT&T (T). These stocks have annual dividend yields of 4.9 percent and 5.3 percent respectively.
Especially in today's world where the Federal Reserve's policy is to keep interest rates near zero, investors turned to high-dividend-paying stocks, such as those in the telecom sector, for income generation.
This week we will get earnings reports from some of the biggest telecom stocks. Holiday sales of smartphones were strong, so we expect to see good earnings from all the major carriers.
The wireless market in the U.S. has become extremely saturated, but there is room for the major carriers to grow if they are successful in converting existing subscribers to higher-priced data plans. They have found success in accomplishing this in recent years, mainly due to the onslaught of low cost Android phones, and should find even greater success if Apple (AAPL) launches a low-end iPhone as expected.
Smartphones are getting cheaper, but the major carriers do not mind. The vast majority of their revenues come from extended service plans, so the more data-hungry smartphones they can sell the better, regardless of their cost. For this reason, analysts will pay close attention to subscriber numbers.
While we would like to make a play on the upcoming telecom earnings, we would prefer to set up a trade on the iShares Dow Jones US Telecom (IYZ) ETF as opposed to any one stock in the sector. Trading the Telecom ETF gives us good exposure to the sector, but removes the risk of picking one stock that could disappoint analysts with their quarterly numbers.
Verizon, AT&T and Crown Castle Int'l (CCI) will all three report earnings this week, and all are included in IYZ. In fact, these three stocks make up roughly 25 percent of all holdings IYZ, so those three stocks alone will have a big impact on the way IYZ trades in the next week.
The last time that the telecom sector reported earnings was during the latter part of October. During the most recent earnings season Verizon posted earnings that were in-line with analyst estimates, AT&T beat analyst estimates and CCI disappointed analysts by one penny.
On October 15 IYZ was trading at $25.08, and by the end of the month it had traded down to $24.42 and continued to fall all the way down to $22.89 by November 15. So in the month following the last telecom earnings season IYZ took a beating, but still managed to fall just 8.7 percent before rebounding. IYZ has still not managed to get back to its mid-October level, but is currently trading at $24.30 and has made back most of its losses.
What we can take from this, is that even if we see some disappointing numbers we can expect the impact on IYZ to be somewhat contained, and any downside we see initially could be quickly erased over the next couple of months. Based on this we would like to look at a hedged trade over a four-month span with some built-in downside protection.
A nice hedged trade on IYZ would be the May 21/24 bull put credit spread. In this trade, you would sell the May 24 put while buying the same number of May 21 puts for a credit of 25 cents. This trade has a target return of 9%, which is 28% on an annualized basis (for comparison purposes only). With IYZ currently trading at $24.30, this trade has 1.2% downside protection.
Chart courtesy of stockcharts.com