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Quarter-End Insights

Plenty of Opportunity in Communication Services Sector

Alphabet continues to power ahead, masking broader underperformance of the group.

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The end of 2021 hasn't been kind to communications stocks as the Morningstar US Communications Services Index has declined about 1% during the fourth quarter (through Dec. 23) versus a nearly 9% gain for the broader market. These figures understate how badly the sector has performed, as  Alphabet (GOOG), which accounts for more than one third of the index's value, continues to power ahead. More than half of the stocks we cover in the sector have declined during the quarter and less than one in three remain ahead of the market's return year to date. Even  Meta (FB) (Facebook) has retreated, now roughly matching the market in 2021, leaving the shares in 4-star territory.

The Communications Sector Took a Beating in the Fourth Quarter


Source: Morningstar analysts

Each Segment Now Offers Opportunities

Source: Morningstar analysts

The carnage during the past quarter has been widespread by subsector, but smaller social media firms have taken the worst beating-- Pinterest (PINS),  Snap (SNAP), and  Twitter (TWTR) delivered the steepest declines. The market appears to have lost confidence in the growth opportunities facing these firms as pandemic-fueled trends moderate and  Apple's (AAPL) privacy changes force advertisers to change their approach. However, each firm continues to build its user base, which we believe will allow for consistent growth as ad spending continues to shift online. Pinterest, our favorite of the group, now trades at an enterprise value at less than 9 times revenue, down from more than 30 times in early 2021, for a firm we expect to increase revenue about 50% in 2021 and an average of nearly 30% annually through 2025. The stock remains one of our favorites in the sector.

Though Tiny Versus Alphabet, Smaller Online Firms Continue to Grow


Source: Morningstar analysts

Media firms have also suffered, with everything from  Disney (DIS) and  Netflix (NFLX) to  AMC Networks (AMCX) declining. We continue to like  ViacomCBS (VIAC), which has trailed only Disney in adding new streaming customers during 2021 while maintaining far stronger revenue per customer than Disney.  AT&T (T) has also been hit, with would-be Warner partner Discovery selling off. We remain optimistic that the new Warner Bros. Discovery will come together in 2022, creating a strong media firm with global reach.

ViacomCBS Is Growing Nicely; HBO Took a Hit to Leave Amazon


Source: Morningstar analysts

Traditional telecom stocks have continued to drift lower amid numerous fears surrounding the competitive environment. We believe the U.S. telecom industry is poised to deliver consistent, albeit modest, growth. Highly indebted  Altice USA (ATUS) offers the most upside if our expectations prove correct, but with considerable risk. Stalwarts like AT&T and  Comcast (CMCSA) also offer attractive return potential.

Top Picks 

 Pinterest (PINS
)
Star Rating: ★★★★
Economic Moat Rating: Narrow
Fair Value Estimate: $67
Fair Value Uncertainty: Very High

We expect Pinterest to benefit from the return of brand advertising spending in addition to growth in e-commerce as the economy continues to recover from the pandemic. The firm also should continue to attract direct-response advertising as most of its users access the app with the intention to purchase immediately or in the future. The addition of try-on features has made engagement with ads stronger and conversion to actual sales more likely. We also think that increasing focus on video pins will bring more brand marketing campaigns onto the platform. All this likely will drive top-line growth and margin expansion for the firm.

 AT&T (T
)
Star Rating: ★★★★
Economic Moat Rating: Narrow
Fair Value Estimate: $36
Fair Value Uncertainty: High

We believe AT&T management is putting the firm back on the right path, bringing a much-needed telecom focus, rebuilding the brand's image among consumers. We expect the wireless business will deliver consistent growth, allowing cash to remain solid after the Warner spin-off. Increased fiber investment should also provide revenue growth and some differentiation versus cable and wireless rivals. We believe HBO Max has built strong momentum that will solidify its place in the living room as Warner joins with Discovery. Even the dividend reduction, we expect the stock will deliver a 4%-5% yield.

 ViacomCBS (VIAC)
Star Rating: ★★★★★
Economic Moat Rating: Narrow
Fair Value Estimate: $61
Fair Value Uncertainty: High

We believe ViacomCBS possesses the content breadth and depth to ensure that it remains entrenched in any traditional television service while also providing plenty of material for Paramount+, its revamped direct-to-consumer streaming offering. ViacomCBS' roster of paid streaming services, which also includes Showtime, has posted relatively strong growth recently since the shift to Paramount+ in March 2021. The free Pluto TV platform is also expanding rapidly as more content from ViacomCBS has been added to the streaming service. We expect that the ongoing international expansion will help to keep growth on track for both Paramount+ and Pluto.

Michael Hodel does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.