NEW YORK (CNN/Money) -
In case you forgot, the telecom business still stinks. Big time. We're talking a Limburger cheese type of stench.
The latest example is Verizon's earnings warning on Tuesday, in which it blamed, among other things, increased repair costs from record-setting rainfall on the East Coast this summer. That's not good news for an industry that's already all wet.
Verizon projected a range for this year's earnings, and the mid-point is 6 percent below the prior consensus forecast.
Telecom trouble
Mind you, even if the East Coast were fortunate enough to have a gloriously sunny summer (grumble), Verizon still has plenty of other problems.
Verizon said that the relatively high unemployment rate (i.e. the proverbial jobless recovery) is limiting demand for corporate telecom services.
In addition, the company still faces tough competitive pressures from long distance companies like AT&T and other smaller local carriers since it and other Baby Bells are required to lease out their access lines at a highly discounted rate.
Even Verizon's biggest strength, its wireless division, is a mixed blessing. Verizon did say that it expects to add 4.5 million wireless subscribers this year, up from projections of 4 million two months ago. But Verizon also cited increased customer acquisition expenses in wireless as a reason for its earnings miss.
In other words, it costs a lot of money to win new customers. Advertising in particular is a big and growing expense as it seems like the annoying 'Can you hear me now?' guy gets more TV exposure than Ben and J. Lo. (For his sake, I hope Verizon isn't paying him with stock options.)
And marketing costs are likely to keep rising as Verizon goes head-to-head against Nextel in the push-to-talk market and the company prepares for wireless number portability this November, which will allow cell phone users to switch carriers and keep their numbers. (For more about this issue, click here.)
Avoid the Bell stocks
Shares of Verizon (VZ: Research, Estimates) fell 4.8 percent on the news Tuesday. Baby Bells BellSouth (BLS: Research, Estimates) and SBC (SBC: Research, Estimates) also got hit, though by slightly less.
And even though it was Verizon that warned, you could argue that BellSouth and SBC should have taken bigger hits. Verizon is arguably the best-positioned company in telecom. How's that for a scary thought?
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Sure, some of the factors behind Verizon's warning are unique, such as the rain and some labor union trouble that led to a lump sum payment that also will hurt earnings.
But the other issues, namely weak business demand and a continued exodus of wireline customers to wireless are problems that all the Bells face. And BellSouth and SBC are not as well equipped to handle the latter problem since the wireless company they co-own, Cingular, is widely acknowledged as one of the weakest carriers.
"Verizon is the best of the Baby Bells but I'm not crazy about the group. This is just the tip of the iceberg," said Greg Gorbatenko, an analyst with Loop Capital Markets.
So don't be surprised if the other Baby Bells also have to lower their earnings targets. Already on Tuesday, Todd Rosenbluth, an equity analyst with Standard & Poor's, reduced his 2003 and 2004 earnings estimates for BellSouth and SBC.
For this reason, Rosenbluth said investors should not get duped into thinking that the stocks are now values. "The industry challenges that Verizon is facing are largely going on with the rest of the industry," Rosenbluth said. "There are unwarranted risks in buying these stocks even on the pullback."
About the only positive thing you could say about Verizon and the rest of the Bells is that they have fat dividend yields. BellSouth's yield is 3.8 percent. Verizon is yielding 4.4 percent and SBC has a dividend yield of 4.8 percent.
But that's not saying much. If a dividend is what you want, look at similarly high yields from banks like Washington Mutual, Wells Fargo and Comerica. Their earnings are expected to increase in 2004 -- you can't say that for the Baby Bells.
Analysts quoted in this story do not own any of the stocks mentioned and their firms have no investment banking relationships with the companies.
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