CCI - Small Cells Big Gains: 5.5%-Yielding Crown Castle's Blueprint For Success

2024-01-13 08:41:50 ET

Summary

• Crown Castle stock has underperformed in terms of growth, but offers a 5.5% yield and attractive valuation.
• The company is well-positioned to capitalize on the demand for enhanced network capabilities driven by 5G.
• Efforts to streamline operations and reduce costs indicate a commitment to shareholder value, despite a cautious outlook on dividend growth.

Introduction

I have to say, chances are I'm not the world's biggest fan of Crown Castle ( CCI ) stock. The telecommunication real estate giant with a market cap of roughly $50 billion is not growing very fast.

Full-year 2023 adjusted funds from operations ("AFFO") are expected to grow by 2%, followed by an 8% contraction in 2024 and a potential 2% decline in 2025.

On top of that, CCI shares returned just 129% over the past ten years, including dividends. While this beat the Vanguard Real Estate ETF ( VNQ ) by roughly 32 points, it was very underwhelming considering the 187% return of the Schwab U.S. Dividend Equity ETF ( SCHD ).

So far, the bad news.

The good news is that the company is yielding 5.5%. It has an increasingly healthy balance sheet and an attractive valuation.

Although it needs to be seen how suitable the CCI ticker is for a total return portfolio, I believe it is a good pick for a well-diversified income-focused portfolio.

My most recent article was written on March 24, 2023. Back then, I gave the stock a Hold rating. Since then, the stock is down 9%, including dividends, which is roughly 30 points below the 20% return of the S&P 500 since then.

Hence, in light of what we will discuss in this article, I'm giving the stock a Buy rating based on the new risk/reward.

Finding Growth In A Low-Growth Industry

During the Morgan Stanley 2023 European Technology Media & Telecom Conference on November 16, the company elaborated on its growth opportunities and transformation.

For starters, Crown Castle is a giant, owning more than 40 thousand cell towers in the United States. Unlike its peer, American Tower ( AMT ), it does not have non-US exposure.

It also owns roughly 115 thousand small cells and 85 thousand route miles of fiber, connecting people in every single metropolitan area.

One major driver of demand in this area is 5G.

According to the company, the ongoing surge in data demand, primarily fueled by the increasing reliance on mobile devices and the broader adoption of data-intensive applications, acts as a key growth driver for its top line.

As consumers and businesses continue to demand higher data speeds and network reliability, the telecom industry faces the need to enhance and densify its infrastructure.

As a result, Crown Castle, with its focus on both traditional towers and small cells, is well-positioned to capitalize on this demand for enhanced network capabilities.

The small cell business segment is emerging as a particularly promising source for growth.

As the limitations of traditional towers become more obvious due to interference and regulatory constraints, the deployment of small cells becomes crucial for addressing the escalating data demands in urban areas.

Crown Castle's strategic investment in small cells aligns with this evolving need and positions the company as a leader in providing densification solutions.

Moreover, the long-term nature of the contracts with major customers, including AT&T ( T ), T-Mobile ( TMUS ), Verizon ( VZ ), and DISH ( DISH ), provides Crown Castle with revenue visibility and stability.

According to the company, the Master Lease Agreements spanning 10 to 15 years establish a solid foundation for sustained growth, allowing the company to plan and invest with confidence, especially when it comes to capital-intensive decisions.

The contract with DISH, for example, adds another layer to Crown Castle's growth prospects.

The 15-year agreement, structured to provide a minimum fee irrespective of DISH's network activity, not only ensures revenue stability but also incentivizes DISH to extensively utilize Crown Castle's towers.

The announcement of Crown Castle as our first tower partner marks an important milestone for DISH as we set our sights on building a first of its kind 5G network in the U.S.," said Dave Mayo, DISH Executive Vice President of Network Development. "Crown Castle brings the experience and broad tower portfolio we need, from major markets to more rural areas, to help DISH bring to life the promise of our standalone, nationwide 5G network. - Via Crown Castle

This strategic partnership positions Crown Castle as a crucial infrastructure provider, contributing to the growth of DISH's network and enhancing Crown Castle's relevance in the industry.

On top of that, there's a somewhat overlooked area of growth.

The company made the case that it is well-positioned to tap into the potential demand arising from non-traditional tenants.

During the aforementioned conference, the company mentioned wireless internet providers, municipalities, fire departments, and police departments as additional sources of activity on its towers.

Furthermore, the convergence of businesses, where cable companies enter the wireless market and compete for customers, presents yet another growth opportunity for Crown Castle.

As cable companies seek to build their own infrastructure to lower costs, Crown Castle stands out as the lowest-cost provider of such infrastructure.

Looking ahead and based on what we just discussed, the growth prospects in the small cell business remain promising.

Crown Castle has a substantial backlog of 60,000 nodes and an increasing number of orders for thousands of nodes.

For the tower business, which is about 70% of our revenue, as we look into 2024, we expect that the business will have about $110 million of the new leasing activity, about 1% churn of revenue and about 3% escalators. And when you add all those 3 things together, we get to 4.5% growth that we expect will happen in 2024 over 2023. For context, in 2023, we are expecting around 5.3% growth in the tower business, so a deceleration going into 2024. I'm sure you'll ask about that in a second, so I'll leave it alone to describe why. - Crown Castle

Moreover:

The growth in small cells, when you add all of those things together that I mentioned, the $60 million plus 2.5% escalators less 1% churn, is about 14% going into 2024. Again, for context, the growth in 2023, we think, is around -- was going to be around 7%, so an acceleration in our small cell business, while we see a deceleration in our tower business. - Crown Castle

Where's The Shareholder Value?

In response to an evolving industry landscape, CCI is focusing on ongoing efforts to simplify, streamline, and centralize its business processes and operations.

These initiatives aim to reduce long-term costs and enhance customer experiences.

Noteworthy achievements in this regard include a workforce reduction and $105 million of annual run rate savings resulting from a restructuring plan announced in July.

Related to this, CCI's capital expenditure plans for 2024, totaling approximately $1.2 billion, reflect a strategic approach to investments.

Importantly, the company aims to fund these capital expenditures without issuing stock (diluting shareholders).

Over the past ten years, the company funded a $21 billion gap with external funding, causing net debt to more than double.

With regard to its balance sheet, the company's overall debt profile remains manageable.

With approximately $5 billion of availability under its revolving credit facility and only $750 million of debt maturities through 2024, CCI enjoys plenty of liquidity.

Needless to say, maintaining an investment-grade credit profile is a key aspect of CCI's financial strategy.

The company has intentionally strengthened its balance sheet over the years, extending the weighted average maturity from 5 to 8 years, reducing the percentage of secured debt to 7%, and increasing the percentage of fixed-rate debt to 86%.

The weighted average coupon on its debt remained at 3.8%, which is a truly strong number.

Also, because of its favorable maturity profile, the company will be able to maintain a healthy leverage ratio and rate on debt in this challenging time.

This also bodes well for its dividend.

The company currently pays $1.565 per share per quarter. This translates to a yield of 5.5%.

In 2024, AFFO is expected to be $6.93, which translates to a payout ratio of 90%, which is elevated.

Next year, AFFO is expected to bottom at $6.80, which translates to a 92%.

These numbers can be seen in the FAST Graphs chart in the valuation part of this article.

This explains why CCI did NOT hike its dividend in 2023. The most recent hike was 6.5% on October 20, 2022.

The five-year dividend CAGR is 7.9%.

Although I do not expect a dividend cut if the company is able to see bottoming AFFO growth in 2025, I also do not expect strong dividend growth in the years ahead.

Valuation

While a 90% payout ratio is far from favorable, I'm OK with the high likelihood of subdued longer-term dividend growth.

CCI offers a juicy dividend and has a healthy balance sheet. If it is able to grow after 2025, it will be able to deliver shareholder value through potential capital gains and its lofty yield.

As we can see below, the company is expected to see a return to AFFO growth in 2026 with a 2% expected growth rate.

Furthermore:

• Currently, CCI trades at a blended P/AFFO ratio of 15.1x.
• Its long-term normalized valuation ratio is 20.9x.
• A return to its normal valuation could result in 13% annual returns through 2026, including its dividend.

Although I doubt CCI will be able to see 20.9x AFFO unless rates come down, I believe the valuation is attractive, making CCI a good play for income-focused investors.

I also expect that CCI will continue to outperform its real estate peers in the VNQ ETF.

Major risks are its efforts to maintain long-term growth and interest rates. However, for the time being, both risks are contained thanks to a proven expansion strategy and a healthy balance sheet.

On a side note, on January 24, the company is scheduled to report its earnings after the market close.

Analysts are looking for $1.69 in EPS , which is based on seven estimates and in line with its 3Q23 result. Over the past four weeks, the company has gotten one upside revision and zero downside revisions.

Over the past four quarters, it has beaten earnings every single time.

Although I do not expect groundbreaking numbers or comments that could result in a significant stock price movement, I am looking forward to comments regarding small cell growth and potential CapEx plans at its customers (like AT&T and Verizon), as these decisions tend to be major growth drivers.

Takeaway

While Crown Castle faces challenges in its growth and dividend growth, the company presents a compelling case for income-focused investors.

With a 5.5% yield, a healthy balance sheet, and strategic investments in small cells, CCI is well-positioned to capitalize on the demand for enhanced network capabilities driven by 5G.

The long-term contracts with major clients provide revenue stability, and efforts to streamline operations and reduce costs indicate a commitment to shareholder value.

Despite a cautious outlook on dividend growth, the current valuation and potential return to AFFO growth in 2025 make CCI an attractive choice for those seeking income and potential capital gains.

For further details see: