Crown Castle: There Are Many Positives Beyond The Sprint Churn (NYSE:CCI)

Dear readers,

Crown Castle International (NYSE:CCI) is one of the two dominant cell-tower REITs on the market. In contrast to its biggest competitor – American Tower Corporation (AMT) it focuses purely on the U.S. market, which results in much lower collection risk due to a more developed legal system, and allows the company to benefit from the best market in the world in terms of data consumption and average revenue per user.

This, along with a high dividend yield of 6.5%, and (as you’ll see later) a reasonable valuation, makes it a prime candidate for income-oriented portfolios.

Over the past two years, CCI’s share price has fallen significantly. This fall can be almost entirely attributed to (and partially justified by) two headwinds which have spooked the market:

1. a surge in interest rates, which caused 10-year yields to rise from 1.5% to 4.5%,
2. and T-Mobile’s (TMUS) acquisition of Sprint, which led to a substantial decline in FFO

I covered both of these headwinds in detail in my latest article called Downside Is Likely Limited. I argued that once we work through the Sprint churn, the REIT had the potential to return to 5% annual growth, driven by organic growth in towers and growth in small cells. In other words, I thought that the Sprint termination was a one-time event, extremely unlikely to happen again, and in the meantime, the underlying business has remained healthy.

In the meantime, the stock was trading at an implied cap rate of 6.9%, about 200 bps above 10-year treasury yields, which I concluded had the potential of resulting in double-digit upside on top of the already high dividends. Even under conservative assumptions of no growth beyond 2025, my bear case yielded a positive RoR. Therefore, I concluded that CCI was a BUY at $95 per share.

Since that article, I must admit, CCI’s performance has been underwhelming with an RoR of 4% compared to 24% of the S&P 500 (SPX). I believe, however, that CCI shares are still worth holding on to, especially now that we have (1) more clarity regarding the potential future path of interest rates and (2) two more quarters of results showing that the underlying business (excluding the Sprint churn) is working well and growing as usual.

Today I explain why I think that both of the aforementioned headwinds have been addressed (and priced in) and why there is little standing in the way of price appreciation for Crown Castle.

The business model remains sound and should support growth in the long term

The above claim may not make sense to you at first glance. After-all, analysts are expecting FFO per share to decline by 8% this year and another 2% next year. But the thing is that this decline is entirely a result of the Sprint churn (described below) and excluding this one-time event, things are actually looking up.

The cell tower business is great because additional revenue can be very easily generated by placing more technology on existing towers. This generates extra rental income with little incremental costs incurred. But when T-Mobile merged with Sprint, it did not need two pieces of the same technology on the same tower, which is why it terminated the Sprint leases.

Now, the good thing is that this was a one-time event, which is unlikely to repeat in the future, as the three remaining big telco providers would likely not be allowed to merge anymore due to anti-monopoly regulations.

On the flip side, it impacted CCI’s bottom line very significantly. First, it inflated 2022 and 2023 numbers due to early cancelation fees and penalties. And second, it cost CCI over $250 Million ($0.60 per share) in annual FFO going forward. Note that the bulk of terminations will be felt next year.

So really, we are going from (slightly) inflated results in 2023 to temporarily impaired results in 2024 and 2025. This is what has caused, among other things, dividend coverage to look tight, with a 2024e forward payout ratio of 90%. But once again, further churn is extremely unlikely. Therefore, what really matters is growth in the rest of the business.

And that’s where CCI has been seeing some good results lately. Demand for towers (excl. Sprint) increased by 5% in 2023 and for 2024 management is guiding towards organic growth of 4.5% for towers and 13% for small cells which combined should drive FFO per share growth (excl. Sprint) of 5%+. And it is this long-term growth that matters to our investment the most.

Interest rates are likely to decline and drive price appreciation

We’ve seen that CCI’s revenues are likely to grow over time. The next step is to forecast what will happen with the cash flows of the company and then determine what these cash flows are worth.

In order to do that, we have to a have a view on where interest rates will head in the medium to long-term because it is interest rates that determine the overall interest expense (i.e. refinancing at a higher rate has a negative impact on cash flows), and ultimately also the stock price.

I explained my view on rates in detail in my article called A Bet On Interest Rates I’m Willing To Make. In short, I believe that inflation is very likely to decline below the Fed’s 2% target by the end of this year as we work through (1) the lag in shelter inflation which continues to be reported at 6%+, despite real-time rents and home prices declining, and (2) the lag in auto insurance inflation which continues to be reported at a whopping 22%, despite real time used car prices down from the highs seen in 2022.

As inflation comes down, the Fed will quite likely want to lower rates fast, to boost liquidity come election time this fall. This, along with other factors such draining of the treasury accounts, could create a nice liquidity boost, explained in detail in my article called It Is All About Liquidity.

If rates come down, even a little bit, interest rate sensitive stocks, including Crown Castle, will pump. In particular, I estimate that a mere 30 bps drop in 10-year yields to 4.0% could deliver 18% of upside by 2025, on top of an already high 6.5% dividend yield. That’s 15%+ annualized. And if yields decline further, there will be much more upside.

Risks

When it comes to my BUY thesis, I see two risks worth talking about. First, the obvious one, is, of course, an increase in interest rates, which would undoubtedly send the stock price much lower. This, however, seems unlikely at the moment and would require a second wave of inflation to materialize. A much more realistic risk is that for whatever reason, CCI fails to deliver on their growth forecast beyond 2025. This could happen, for example, due to a slower than expected roll out of 5G and small cells, which is something that has happened many times in the past. In this case, however, I don’t expect meaningful downside from current levels, as long as interest rates stay where they are or decline.

Bottom Line

The timing of the Sprint churn combined with a period of high-interest rates has hit CCI hard. But I believe that both of these headwinds have now been priced in. It is important to recognize that underneath the Sprint churn, the underlying business has been growing consistently by about 5% per year and this level of growth is expected to continue in the future. Once the company works through the one-time churn event, there is little standing in the way of further revenue growth. Moreover, inflation and interest rates seem to be at a turning point and could decline towards the end of this year, which would unlock substantial upside in stock price. I rate CCI a BUY.