Investment-grade telecom credits are well-positioned to outperform the rest of the corporate market in 2002, according to two runners-up in the 2001 Institutional Investor All-America Fixed-Income Research Team. Scott Shiffman, telecom analyst at Lehman Brothers, says the sector is at near-historic wides on an overall spread basis relative to the Lehman Brothers investment-grade credit index. Telecom spreads comprised 129% of the index last week, just off their cheapest levels of 132%. Shiffman says fair value is approximately 110%.Doug Colandrea, analyst at Morgan Stanley, expects telecom credits to outperform the broader corporate market by 20 to 30 basis points in 2002, as companies focus on strengthening their balance sheets and producing free cash flow. He advises investors to focus on senior unsecured debt in 10-year maturities, which he says is the most liquid part of the curve.
Both analysts cite Qwest Communications (Baa1/BBB+) and WorldCom (A3/BBB+) among their top picks. Shiffman says Qwest has a "unique set of assets which should be the first to benefit when the economic environment begins to turn up," while Colandrea believes the bonds are oversold. As for WorldCom, Colandrea likes the company's Internet and data businesses. Shiffman believes it will generate positive free cash flow by the second half of 2001. He recommends the Qwest 7.25% notes of'11, which traded at 315 basis points over Treasuries last Tuesday, and the WorldCom 7.5% notes of'11, which were 282 over the curve. Shiffman says the Qwest paper should be trading 10 basis points better than Sprint's 7.625% notes of 11 (Baa1/BBB+), while WorldCom should trade 15 basis points back of Sprint. Last Tuesday the Sprint paper traded at 255 basis points over the curve.
In spite of the analysts' optimism, Wayne Schmidt, portfolio manager at Advantus Capital Management in St. Paul, Minn., is not ready to add exposure to the sector. He argues that telecommunications companies will continue to have to borrow and spend money upgrading their technology, and says he is concerned about continued issuance putting pressure on spreads.