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Morningstar | Crown Castle Meets Expectations in 1Q, but We Think It Needs to Do Better to Justify Valuation

Crown Castle's first-quarter results were in line with its 2019 outlook, which it maintained following the quarter. While the firm's reported revenue, net income, and AFFO all exceeded consensus, the outperformance relative to our first-quarter projections is entirely attributable to higher tower-services revenue, a figure that is historically choppy and not a core driver of the long-term growth story. Site rental revenue and margins, which are the keys to Crown's fortunes, were in line with our expectations. Crown continues to meet its targets, and the stock's upward trajectory has left it well above the $84 fair value estimate we are maintaining. However, given the heavy capital investment its small cell strategy requires, we don't see how the current, steady growth can justify the current stock price. In our view, Crown needs to see a big spike in sales relative to its investment, but we see no indication that type of inflection point is near. Until Crown can demonstrate better leverage on its heavy spending, we are likely to maintain our no-moat rating and seemingly low valuation estimate.

Companywide, site rental revenue growth was 5.7% year over year, consistent with the roughly 6% growth we project for 2019. Gross margin and adjusted EBITDA margin were 71.2% and 57.6%, respectively, both slightly below our full-year projections.

Crown's tower business, which is not currently the strategic focus but still accounts for 70% of revenue and is where we think the firm has competitive advantages, was the better performing segment in the quarter. Site rental revenue growth exceeded 5% while site rental gross margin expanded 140 basis points from last year's first quarter. We expect tower margins to continue expanding. The firm has not been adding new towers to its portfolio, so most of the segment's growth will come from contractual escalators and amendments from existing tenants as well as incremental tenants on existing towers, all high-margin additions.

Despite towers accounting for only about one quarter of the firm's discretionary capital spending, we estimate the segment to maintain revenue growth near 6% annually throughout our 10-year forecast, only 200-300 basis points below the average annual growth we project for the investment-heavy fiber segment.

Crown continues to aggressively pursue its small cell buildout, but we are not yet convinced of the strategy's wisdom. Year-over-year fiber site rental revenue growth was 6.4% in the first quarter, following a year when the firm put up a record number of small cell nodes—about 7,500. We estimate small cell revenue growth was low double digits, but small cells currently only account for about one quarter of the segment's revenue, with fiber solutions (growing about 5% annually) providing the remainder. The segment's gross margin was just over 66%, roughly flat sequentially and less than 100 basis points below our full-year projection.

The firm expects to deploy twice as many new small cell nodes in 2019 as 2018, so we expect fiber revenue growth to accelerate throughout the year and project 2019 fiber site rental revenue growth above 8% before accelerating the next two years. However, the segment's capital intensity was 75% last year, and we project it to be around 90% in 2019, so the revenue growth is not yet sufficient. In our view, this will not be an attractive business until Crown flips the switch to be able to deploy more colocated rather than anchor nodes, which will drastically reduce capital intensity. However, management indicated that the current rollout is still about 80% anchor nodes, and we project anchor nodes will continue to compose the majority of new deployments over the next five years.