Jetsons “Home of the Future” Opportunities (Part Two)

What's David Dittman teasing as "Not Your Typical Utility?"

By Travis Johnson, Stock Gumshoe, November 4, 2014

People can’t get enough of the “Internet of Things” and the role that plays in the “smart home” of the future (or perhaps the present), so we’ve gotten a few questions about David Dittman’s Jetsons spiel in recent weeks — particularly since we covered the first stock he was teasing but didn’t get to the others.

So let’s rectify that, shall we? If you want to read part one of this de-tease-ification, you can check that out here. It’s OK, we’ll wait.

All set? So yes, the “Jetsons Home of the Future Opportunity #1” was AT&T (T), which, as we said back then, is a fine dividend-grower with a pretty strong duopoly business as they essentially share the profitable part of the wireless telecom market with Verizon (VZ) … assuming that Sprint and T-Mobile don’t get too far in their attempted price war.

How about #2? Let’s check out our clues:

Jetsons’ Home of the Future Opportunity #2—Not Your Typical Utility

“”This juggernaut has a market cap of $203 billion. They’ve formed a new partnership with a tech company that makes it possible for homeowners to control their homes through smartphones and tablets.

“Their website gives customers step-by-step instructions on how to sync thermostats, security systems, door entry and fire alarms—all at no extra charge.

“So how are they going to make money?

“That’s the beauty of it. Once customers experience all the conveniences of Smart Homes, it practically locks them in as customers for life. Haven’t we all considered changing a service provider and decided against it because of the hassle?

“Out of fairness to my paying subscribers, I can’t reveal the name of this company here. But I can assure you it’s not the typical sort of utility company you’re probably thinking of.

“At the moment, it yields 4.4%. So it’s paying out like a traditional utility, only better…

“What’s more, if it increases its payout ratio to the level of other companies in its sector, your “yield on cost” would double to 10%.

“But don’t wait for this to happen. This company is a strong buy now.”

So… Hoodat? Well, whaddya know — this is the second giant of US Telecom, Verizon (VZ). And we talked about it plenty last time around, so you can go back and see that if you want more chatter about VZ. None of the “traditional” utilities are anywhere near as big as T and VZ in the $200 billion neighborhood — I think the largest publicly traded one is probably around a $50 billion market cap. That’s largely because there are no national utilities except for these telecom firms, most of the biggest electric, gas and water utility companies (and even cable telecom) are still regional and cover just a handful of states, and many are much smaller…. with the flip side that, as you have no doubt noticed as a consumer, many are in distinctly non-competitive (though highly regulated, including price controls) businesses.

And yes, Verizon does have a partnership with a tech company (private Greenwave) to build up a smart/connected home business, starting with new routers for FiOS customers… and they’ll also happily sell you the smartphones and tools to use in that connected home, supporting the Nest thermostat from Google among many other products. This is still very much an industry in flux, as evidenced by the fact that Verizon dropped their “smart home/connected home” business last year because it wasn’t working and they didn’t have a real strategy (that was a partnership with the old Motorola 4Home business, which I think has now ceased to exist after Google (GOOG) bought Motorola and then sold off that part of the business to Arris (ARRS)).

So no, Verizon’s not going to drive customer retention or acquisition simply because they’re installing FiOS routers that can run a “smart home” and monitoring service — not only because those are fairly high-end services, but because it’s going to take a long time to populate their customer base with these new systems and convince them to upgrade to monitoring… and because, well, the wireless business really completely dominates Verizon’s income statement, wireless EBITDA is about 5X as large as wired (FiOS and landline phones) EBITDA — though FiOS is still growing nicely.

I’m not all that impressed with the assertion that Verizon is offering instructions about how to sync various in-home systems, that’s just a basic customer service offering — telling people how to connect their Nest thermostat to the new Verizon routers that can also communicate with many security services, etc. It may make the service stickier, but people who are paying for FiOS are probably pretty “sticky” anyway, particularly as that’s probably bundled with their wireless bill and the only other option is likely to be the local cable company, which people hate even more than they hate Verizon.

And yes, if Verizon had the same payout ratio as AT&T, it would also have very close to the same dividend yield — though that wouldn’t make it a 10% yield on cost in my book, so perhaps he’s hinting at a higher payout ratio than that. Right now, as of the last quarter, Verizon’s payout ratio is 42% and AT&T’s is 56% (payout ratio is the percentage of earnings that are paid out as dividends — 50% is pretty good and should be eminently sustainable for a utility-type firm, VZ and T both had payout ratios well above 100% for many years, until quite recently, partly because they invested heavily in building out networks). VZ’s current dividend yield is 4.4%, T’s is 5.3%. Traditional utilities generally have much higher payout ratios (at least 80% for the ones I’ve scanned), and somewhat lower dividend yields (the utilities ETF, XLU, yields about 3.5%) because, though telecoms may provide a modern necessity service akin to electricity or gas, they’re still considered a bit riskier and more volatile and competitive than your typical “widows and orphans” utility.

“Jetsons’ Home of the Future Opportunity #3—Low-Risk Yields Up to 12.5%

“Despite their country’s sluggish economy in recent years, this foreign company continues to grow. Why? It’s because they have a strong presence in Latin America and European countries.

“They have about 300 million customers (roughly the size of the U.S. population), and 83% of them live outside of their home-base country.

“They’ve yielded as much as 12.5% in the past. Right now the shares pay 6.5%.

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“It’s rare to find a company paying high yields with a stable business model. Many high-yield companies are in real estate or energy, where a bubble burst could leave you shirtless.

“High yields and a strong international presence are two reasons serious income investors should have this company in their portfolio.”

The Thinkolator has an answer for us on this one, too — though it’s not quite a 100% lock of a match. This is almost certainly the Spanish telecom giant Telefonica (TEF), which is down quite a bit this year (thanks in large part, one assumes, to general weakness in the both the currencies and the economies of most of their large European and Latin American countries where they do business). TEF does pay a high yield and have a focus on shareholder cash returns, which is good, and they are huge and diversified and invest heavily in R&D and network buildout, though I have no idea whether the “smart home” stuff is a major part of their strategy in any way.

The current trailing dividend yield is about 6.8%, and it did indeed spike up to the 12% range briefly, but for most of the past five years it has traded with a dividend yield in the 4-7% range (the dividend has recently been paid in two installments, like many European companies, so it’s not as steady as a quarterly or monthly dividend payer who manages the size and growth of the dividend more ardently, like VZ and T do).

And yes, though it’s a pretty steady business it is also economically sensitive to some degree… they are more diversified internationally than most big telecoms, with about half of their sales/earnings from Europe (and roughly 20% from their home country) and the other half from Latin America (with Brazil being by far the largest chunk there). Like VZ and T, they are largely focused on wireless, though broadband service is also a big driver — they are trying to cement their hold on broadband in Brazil with an acquisition, and the Euro/Latin American telecom sector is almost always buzzing with takeovers of one sort or another as the huge number of cross-national competitors jockey for position.

They carry quite a bit of debt, more even than the big US telecoms, but have been focused on paying it down in recent years, at least until the next time they want to make a big acquisition… and, well, it’s a solid company that’s a bit racier than VZ and T and certainly has a different customer base. When reporting in US$, their results are going to fluctuate a lot based on the movement of the Euro, which most people seem to think should go down as they try to boost the economy, and of the South American currencies like the Brazilian Real (which have already fallen a lot in most cases). If the euro falls, in particular, that’s likely to make the results look less good — though it won’t mean they’re operating badly, just that the currency they’re doing much of their business in and operating in at HQ is worth less in US$ terms. I think it’s valuable to have non-US$ exposure in a portfolio, so this is an interesting one for the yield-focused, but I haven’t looked into the company’s financials in any great degree.

“Jetsons’ Home of the Future Opportunity #4—The Utility That Returned 281%

“It’s not often that you see triple-digit gains from utility stocks in a relatively short time. Yet this company is up 281% in the past five years.

“We’re convinced this trend will continue because they made a major acquisition in 2011 that gave them access to 20 million new customers. They’re also getting into the $600 billion Smart Homes opportunity.

“Right now, they’re offering monthly Smart Homes services to their growing number of customers so they can lock them in for the long haul.

“We think this one is a winner… and is almost certain to be a monthly cash-generating machine for years to come.”

This one is, again, somewhat less than a 100% lock of a match, but the best match the Thinkolator can locate is the most hated company in America, Comcast (CMCSA). Well, among the top two most-hated, at least — but they are trying to merge with the other one, Time Warner Cable (TWC). The hitch? They didn’t really get 20 million new customers with the NBC Universal merger in 2011, though they certainly dramatically raised their profile — and the proposed deal to acquire Time Warner would be adding close to 20 million subscribers.

Comcast is a cable company, of course, and also a huge content-creation company — and the leading national high-speed broadband company in the country now, which is the biggest concern that regulators have with the proposed Time Warner merger, both because of price competition and because of net neutrality issues (they don’t care nearly as much if cable companies merge, usually, because cable companies don’t compete with each other for customers — almost no one in the US has a choice of cable providers). The company generates huge amounts of free cash flow, more than $10 billion a year (market cap is about $140 billion), though the earnings fluctuate quite a bit due to up-and-down capital investments.

Comcast pays a growing dividend (raised every year since 2008), but it’s not a high current yielder — yield is about 1.6% now. They face some pressures, to be sure, including people dropping cable TV or home phones, but they do fight that pretty effectively by bundling and charging much higher prices for broadband if you buy it unbundled… and most of the US would give up a lot of things before they give up their home broadband. It’s not quite a monopoly, but it’s pretty close — DSL and satellite broadband can’t compete with Cable on download speeds, and Verizon’s FiOS fiber optic offering reaches a really paltry number of homes in the grand scheme of things.

And yes, Comcast’s Xfinity is perhaps the most aggressive of the big telecom “bundled” service offerings to include home monitoring and security services, which seems to be the angle into the “smart home” that most of the telecom companies are looking at. It’s a very powerful company, effectively still family-controlled, and it is certainly getting more credit for being a behemoth than it was a few years ago (for many years it traded at about 10-12X free cash flow, as the price soared over the past year or two it got briefly up to 25X free cash flow, down closer to 20 now), but it’s arguably still reasonably priced for a dominant near-monopoly at about 17X earnings and it’s still expected to grow earnings in the teens for the foreseeable future. There are uncertainties, particularly with the approval of and execution of the Time Warner Cable merger, but it’s hard to argue against Comcast unless you want to make the point that it’s more expensive than the average stock. Or, of course, unless you’re one of the millions of Americans who hates Comcast so much that you’re unwilling to own the stock… or prefer to stay away from companies with sneaky family control provisions.

So… no one gets a flying car today, but if David Dittman had sent around a teaser pitch saying he had four megacap telecom stocks he likes, would you have ponied up some cash for his newsletter? The Jetsons stuff is obviously not really material yet for any of these companies, though my impression is that Comcast and AT&T are the ones most actively marketing this future at the moment, but they’re all strong companies with huge customer bases and, in most cases, large dividends (Comcast’s not so much — though they certainly have the wherewithal to raise it much more aggressively if they want to). Any of them appeal to you, or have reasons to shy away from one of these names? Let us know with a comment below.


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