Published: December 10, 2009
I hadn't spoken to my friend Harriet for
almost a year. We were really close in university, but with her
living several hundred miles from me, we drifted apart. So a few
weeks ago, I picked up the phone, dialed, and awaited with
pleasure her cheery "Hello."
Instead, a tinny voice on the other end informed me, "This line
is no longer in service."
I grabbed my electronic address book. "Harriet has a cell
phone," I thought to myself. I never call her on that number
because of the sky-high charges she incurs, but today was an
I dialed and held my breath. Almost instantly, I heard her
upbeat "Hello." "Sorry, to phone you on your cell," I said, "I
know it's expensive for you."
"That's fine," she replied, "I'm just happy to hear your voice.
But you know what, I just cut the cord."
"Cut the cord?" I thought. "Come on Harriet; it's awfully late
in life for you to get pregnant."
"Yeah," she continued. "Phil and I dropped our land-line phone a
month ago. We only have a cell phone now. But call me at this
The Fall of Fixed-Line Service
Unfortunately for telephone companies, my friend Harriet's story
is not unique. The National Center for Health Studies estimates
that at the end of 2008 one out of every five homes relied
exclusively on cell phones. This number grew by about +2.7% over
the previous year.
The trend is reflected in the performance of the benchmark
iShares Dow Jones U.S. Telecom Index (NYSE: IYZ), which has
sharply underperformed the S&P 500 since the March lows.
Then why on earth would I want to turn your attention to the
opportunity in a widely shunned group of income stocks --
land-line phone firms?
I imagine you're skeptical. After all, you've likely seen the
headlines about land-line losses, or maybe like my friend
Harriet, you've come to rely exclusively on your cell.
Telecom Alchemy: Turn Copper Into Gold
But for income investors, the land-line phone company story is
undeniable. These companies throw off piles of predictable cash
flow that power their high dividend yields. The group has had
some bad press and is out of favor, but that just makes the
shares more undervalued and their yields more robust.
In particular, one group of telecoms -- Rural Local Telephone
Exchange Carriers or RLECs -- offer sky-high yields. The pun is
all too easy to make: They are relics of an earlier age when
cell phones were only for the very affluent and not in
But relic or not, you can't argue with their dividends. As of
late November, the average yield of the six major RLECs is
What powers these strong yields are their services and
geographical focus. RLECs provide traditional land-line service.
They may offer wireless, but land-line traffic comprises the
bulk of their revenues.
They normally operate in rural, small town, or suburban America,
outside the big cities. Their rural roots are a great advantage
in today's intensely competitive telecom landscape. Aside from
losses to wireless companies, traditional telecoms also have to
compete with cable operators who provide bundled television,
phone and Internet.
But because population is sparse in the areas that many RLECs
operate, other providers are not particularly interested in much
of their territory and competition is far less than in big
cities. The result is that RLECs are somewhat shielded from the
often intense price competition while having a near monopoly
over their service areas.
The Secret Weapon Increasing Business
The most interesting feature of the regional telecoms is that
they are still able to increase their revenues, thanks to
broadband Internet. As fast as fixed-line customers like Harriet
cut the cord, broadband customers are hooking it up.
Broadband is a source of rapid growth for RLECs. For one of my
favorite companies, only about 35% of its customers are
broadband consumers. Moreover, only 88% of the company's access
lines are currently broadband enabled, so there are still plenty
of growth opportunities.
Investors should watch out for the debt of the rural telecoms
The spending required to constantly upgrade technology and
infrastructure tends to create high debt levels. If inflation
were to rise sharply and interest rates skyrocket, these
companies could need their cash flow to pay interest or reduce
debt rather than reward investors with dividends.
But for at least the time being, investors can lock in some
appetizing yields in this stable -- yet out of favor --
-- Carla Pasternak
P.S. -- How exciting is the opportunity in RLECs? So exciting
that I covered the section in the "Feature Article" of my
issue. In my issue, I also covered my two favorite picks
in-depth -- diving into their mechanics behind their 7.9% and
13.0% yields. To subscribe today and read my analysis,
follow this link.