Select communications stocks remain solid bets to weather what’s left of this recession. They’re also prime growth bets for the eventual recovery.

	Roger Conrad PFNewsletter.com
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For more than a century, the basic telephone had been a mainstay in American homes and businesses. That earned phone stocks the moniker of being safe enough for “widows and orphans,” even in the worst markets.

Today, however, landline phones are rapidly being replaced by wireless and broadband, which in turn have become critical to communications companies’ earnings.

Many believed that consumers and businesses would cut back these services in a recession, crippling phone company earnings as never before. Even the strongest communications companies have been sold off with the market.

The good news: First quarter 2009 sector numbers have shown, once again, that the fears are unfounded. In fact, the biggest and strongest communications players are thriving like never before, as demand for global connectivity continues to grow

Best of all, the bar for success is still low for the top of telecom. Coupled with the big yields available, that adds up to a superb total return opportunity in the best of the sector over the next 12 to 18 months.

Dialing for Dollars

Without a doubt, Verizon (NYSE: VZ) and AT&T (NYSE: T) have emerged as the industry’s kings. Their “sleepy” managements recognized early on the potential of wireless phones and have never flagged in growing their reach and range of services in the business.

For more than a decade, detractors have focused on the steady erosion of their traditional phone businesses rather than the outsized growth of their wireless businesses. As a result, they’ve missed the point that not only are new services growing faster, but, as the numbers have shown again and again, they’re every bit the 21st century essential service that traditional phones were in the 20th.

First quarter numbers retell the tale. Verizon’s headline earnings, absent one-time costs for the Alltel merger, came in at 63 cents, up 10.5 percent and well above the Street’s 61-cent projection. And despite $3.7 billion in capital expenditures to build out the network, free cash flow was $2.7 billion, double last year’s levels.

Revenue including the Alltel properties rose 11.6 percent, as the company passed AT&T in terms of wireless subscribers for the first time since the latter’s merger with BellSouth. The company’s wireless division contributed 56.6 percent of total sales, up 29.6 percent on the year as it added 28.8 percent more customers for a total of 86.6 million users.

Customer turnover, or “churn,” remained at just 1.14 percent, still the lowest level in the industry. Moreover, data revenue--the category that includes all new wireless applications--rose by an explosive 56.2 percent.

As has been the case for many years now, the company lost traditional local phone service customers. But it also added 299,000 net new customers for its state-of-the-art FiOS TV service and a record 298,000 net new FiOS Internet customers. The FiOS base is now at 2.2 million FiOS TV customers and 2.8 million FiOS Internet customers.

The company also continued to be a leader in cost efficiency, as monthly cash expenses per customer fell to just $27.38. And it moved ahead on its state of the art LTE 4G network, which will transmit data at many times current speeds.

AT&T posted steep pension expenses due to the market correction of about a nickel a share. Earnings per share, however, still came in at 53 cents, and the numbers behind it looked even better. Free cash flow, for example, was $4.6 billion, up from $700 million a year ago.

Wireless operations were the star, paced by the company’s immensely profitable partnership with Apple (NSDQ: AAPL) and its iPhone. Post-paid subscriber rolls rose 24 percent, and cash flow margin surged to 40 percent. Those numbers are particularly impressive in view of the effective subsidy AT&T has used to encourage adoption of the iPhone. Data revenue, meanwhile, rose 39 percent.

On the wireline side, the company’s U-verse platform added 284,000 customers in the quarter, an actual acceleration from last year’s pace. Penetration has now hit double-digits in all major markets, and attach rates ran above 90 percent, with overall penetration nationwide at 13 percent. Even the pace of basic wireline losses diminished, and actual revenue per household rose by 2 percent.

Verizon and AT&T are cheap, yield north of 6 percent, and are buys up to 35.

Cash Flow Kings

Rural telephone companies sport even greater yields because most investors see them as wireline businesses that continue to erode. That, however, misses the point entirely.

Rather, the best rural telephone companies are cash flow generators. Even the most aggressively run aren’t likely to grow much in coming years. But they can pay out double-digit distributions almost indefinitely thanks to their ability to cut costs and upsell existing customers to advanced wireline services such as broadband Internet service and digital television.

Income Portfolio pick Frontier Communications (NYSE: FTR) added Internet customers at a slower rate than last year. And it also dropped traditional phone business at a slightly higher rate as overall revenue dipped 5 percent.

The company’s cash flow generating model, however, continues to shine. Free cash flow after capital costs was up 13.5 percent, covering distributions by nearly 2-to-1 and allowing further buybacks of debt and shares. Revenue per customer from upselling services was solid as operating cash flow margin remained a strong 53.5 percent.

Frontier’s biggest news, however, is the announcement of a transforming asset purchase deal with Verizon. Frontier will purchase 4.7 million lines in 14 states essentially in exchange for issuing Verizon shareholders $5.2 billion in stock and assuming another $3.3 billion in debt. The deal also includes a Frontier dividend cut to an annual rate of 75 cents a share.

A similar deal derailed FairPoint Communications’ (NYSE: FRP) fortunes earlier this year. Frontier’s purchase should avoid that fate, thanks to regulatory experience in 11 of the states and vastly improved credit conditions in recent months. It’s also very cheap. Until this deal closes, however, Frontier Communications rates a hold.

In contrast, Windstream (NYSE: WIN), slightly larger than Frontier, also continues to shine in the cash flow department. Operations did take a hit in the first quarter, as the traditional phone service eroded at a faster clip. Overall revenue fell 6 percent. Headline earnings per share, meanwhile, took a hit from a $90 million charge to bring its pensions up to par.

Unlike Frontier, however, Windstream actually accelerated the pace of its Internet additions, doubling its customer base from year-earlier levels. Data and digital television sales were also strong, as the company continued to upsell its customers and increase its overall service penetration. That’s a trend that will continue, thanks to recently announced acquisitions of other rural phone companies, now selling at depressed prices.

Management revised its full year target for free cash flow to between $705 million and $775 million. That assures roughly 2-to-1 coverage of the distribution--and plenty of room for share and debt buybacks as well as still more acquisitions. A great dividend play and poised for growth when the economy recovers, Windstream is a buy up to 10.

Finally, cable television giant Comcast (NSDQ: CMCSA) also announced strong first quarter results, a great sign for Income Portfolio holding Comcast Corp 7 Percent Preferred B (NYSE: CCT).

Headline earnings of 27 cents a share topped expectations of 23 cents and came in comfortably above last year’s 24 cents. Free cash flow nearly doubled to $1.4 billion, leaving open the possibility of another price-increasing boost in Comcast’s already solid BBB+ credit rating. Buy Comcast Corp 7 Percent Preferred B below 25.

Roger Conrad is regularly featured on television, radio and at investment seminars. He has been the editor of Utility Forecaster for 10 years and is an associate editor of Personal Finance, associate editor of By George!, and is editor of Roger Conrad's Power Plays.

Mr. Conrad co-authored the books Market Timing for the Nineties and The Agile Investor with Stephen Leeb. His new book about deregulation and the future of energy services companies, Power Hungry, is now available.
Mr. Conrad is uniquely qualified to advise on income-producing equity securities. He founded the newsletter, Utility Forecaster, in 1989. During the past decade it has become the nation's leading advisory on electric, natural gas, telecommunications, water and foreign utility stocks, bonds and preferred stocks.

Utility Forecaster was named Best Financial Advisory by the Newsletter Publishers Association in 1997 and won Honorable Mention in 1999.

Mr. Conrad tracks a universe of more than 250 essential services securities, employing a rigorous five-stage methodology that includes a proprietary safety rating system and a value index that compares prospective total returns with a security's current price-to-earnings ratio.

As a member of Money Growth Institute, Mr. Conrad focuses primarily on securities that provide a combination of income and the potential for long-term capital appreciation. His work is particularly important for those whose investment objectives include current income or those who face mandatory distributions from their retirement accounts.

Conrad has a Bachelor of Arts degree from Emory University and a Master's of International Management degree from the American Graduate School of International Management (Thunderbird).