The market saw interest rates rise in the second quarter on expectations that the Federal Reserve is ready to raise interest rates soon. Wall Street pundits see the rate increases starting anywhere from September to December to not until 2016. A new report from Merrill Lynch makes the case that so-called rate trade stocks that were bond proxies during the years of a low-rate environment may have seen unwarranted sell-offs and could be ready to trade higher.

The Merrill Lynch team notes in the report that numerous investors that they have spoken to recently take it as given that the telecom stocks have a significant negative correlation with interest rates. That is an interesting position given the fact that the S&P telecom stocks actually outperformed the market by 0.6% during the period of rising interest rates.

While the analysts see the rural local exchange carriers (RLECs) best positioned to rebound during the last half of 2015, owning a large cap leader is a good idea as well.

AT&T

This company will report quarterly results on July 23, and the Merrill Lynch team sees upside to current forecasts. AT&T Inc. (NYSE: T) has to be one of the most ignored dividend plays on Wall Street. In fact, AT&T is the third most underweighted security, and the most underowned by active fund managers, according to Merrill Lynch data. While growth has been admittedly slower over the past few years, the company continues to expand its user base. Strong product introductions from smartphone vendors has not only driven traffic, but increased device financing plans. That is an area that many on Wall Street believe could lead to some earnings weakness.

Many on Wall Street also think the closing the DirecTV deal will remove a lot of lingering questions, especially where the company’s big dividend is concerned. It is a good bet that the synergies created by the deal are being underestimated by Wall Street, and many analysts see upside to wireless margins.

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The Merrill Lynch team notes that AT&T will host a full analyst day and they believe the company will highlight growth projections, strategic initiatives and offer a full pro forma look at AT&T/DirecTV combined company. The company’s increased involvement in Mexico is also cited as a positive for future earnings.

AT&T investors are paid an outstanding 5.4% dividend. The Merrill Lynch price target for the stock is $40, and the Thomson/First Call consensus estimate is $36.74. Shares closed Wednesday at $34.73.
CenturyLink

This is the largest of the RLECs and is expected to continue to get a large dose of government money to provide continuing Internet service in rural areas. CenturyLink Inc. (NYSE: CTL) is a global communications, hosting, cloud and IT services company enabling millions of customers to transform their businesses through innovative technology solutions. CenturyLink offers network and data systems management and big data analytics and IT consulting, and it operates more than 55 data centers in North America, Europe and Asia. The company provides broadband, voice, video, data and managed services over a robust 250,000-route-mile U.S. fiber network and a 300,000-route-mile international transport network.

The Merrill Lynch analysts like the stock as it transforms itself from a telecom to a technology company. The company got hit hard as analysts focused on the slight second-quarter revenue miss instead of the long-term potential growth prospects. They also feel that revenue growth going forward and especially in 2016 should lower the ongoing worries of a dividend cut at the company.

CenturyLink investors are paid a gigantic 7.33% dividend. The Merrill Lynch price target is posted at $42, and the consensus target is $35.25. The stock closed trading on Wednesday at $29.67.

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Frontier Communications

This is another RLEC that the Merrill Lynch team likes, and ongoing external issues have pressured the stock. Frontier Communications Corp. (NASDAQ: FTR) offers broadband, voice, video, wireless Internet data access, data security solutions, bundled offerings — including specialized bundles for residential customers, small businesses and home offices — and advanced business communications for medium and large businesses in 28 states. Frontier’s approximately 17,800 employees are based entirely in the United States. The Merrill Lynch analysts note that the company has taken broadband share in almost 80% of operating markets last year.

The company got final approval in May for an $8.5 billion acquisition of Verizon’s wireline operations that were providing services to residential, commercial and wholesale customers in California, Florida and Texas. The Merrill Lynch team points out that sectorwide overhang is the $8 billion bond deal the company has to complete to fund the purchase. In anticipation, bond investors have widened out the bonds at Frontier and across the sector, which has in turn pressured the stock.

The Verizon assets should be accretive and help the company grow free cash flow, which could help Frontier to begin to grow the dividend again.

Frontier investors a paid a massive 8.66% dividend. The Merrill Lynch price target of $9 is well above the $6.85 consensus target. Shares closed on Wednesday at $4.88 apiece.

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Sellers jumping on these stocks every time rates rise is unwarranted, according to the Merrill Lynch analysts. Patient growth and income investors with a long-term time horizon should still find solid value here.

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