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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
exception.
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 number anytime."
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
everyone's pocket.
But relic or not, you can't argue with their dividends. As
of late November,
the average yield of the six major RLECs is 11.1%!
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 --
industry.
Good Investing,
Carla Pasternak's Dividend Opportunities
P.S. -- How exciting is the opportunity in RLECs? So
exciting that I covered the section in the "Feature Article"
of my December
High-Yield Investing 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.
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