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Better value in telcos than tech

Tony Featherstone compares tech with telco and looks at the value of three small-to-large caps: Telstra, TPG and Amaysim.

Finding value in the telco and information technology sectors is hard for different reasons. Several telco stocks have slumped, amid rapid industry change and sector uncertainty. Many tech stocks have zoomed this year, taking them well beyond value territory.

I noted some promising tech stocks in the past two years for the Switzer Super Report, among them Afterpay Holdings and data-centre operator Asia Pacific Data Centre Group. Both look fully valued after strong gains this year. Another favoured tech stock, Freelancer, looks better value.

That said, my preference for tech investing is to use a fund approach, either active or index, or invest directly in large offshore tech stocks. ASX has done a good job of expanding the local listed tech sector, but most companies are small and speculative, suiting active investors.

Favoured tech funds include BetaShares’ Global Cybersecurity Exchange Traded Fund, ETF Securities’ new ROBO Global Robotics and Automation ETF, and the Platinum International Technology Fund for those who prefer active over index funds.

In Australia, the telco sector looks a better bet than tech on valuation and company-quality grounds. Granted, it’s an awkward comparison; the telco sector is much larger and its key players are utilities. Still, both sectors benefit from higher rates of technology adoption.

Vocus, $2.82 at the time of that report, rallied to $3.71 within weeks of the report after takeover approaches, later withdrawn. Vocus has since eased to $3.02 and looks fully valued, the main attraction being the potential of another takeover bid.

Small cap Amaysim Australia tumbled from $1.80 at the time of my report to $1.50, but has since rallied to $2. I favour Amaysim at the current price, mostly because it can deliver a larger number of customers, at low acquisition cost, to a telco predator. More on Amaysim below.

Here is a selection of telco stocks to consider. I’ve broken them into a large-cap, mid-cap and small-cap stocks. Conservative portfolios should stick to the larger end of this spectrum; active investors and traders might focus on the smaller fry.

1. Large Cap: Telstra Corporation

I have avoided the telco giant for the past two years, principally because of concerns about its valuation and dividend sustainability. Prior to that, Telstra had been a mainstay for an income portfolio I developed and wrote about for the best part of a decade.

But every stock has its price. Telstra has fallen from $6.61 in early 2015 to $3.42 – a five-year low.

Fears about how Telstra will fill a $3 billion earnings hole caused by the National Broadband Network (once fully rolled out); regulatory risk; intensifying competition in the mobile-phone market (thanks to TPG Telecom’s entry); and a nasty dividend cut, have crunched its share price.

That’s the bad news. The good news is that Telstra should be able to plug at least half of its NBN-related earnings hole through productivity gains as it streamlines operations. Telstra’s latest investor day did not give much detail on specific cost savings, but broad comments that the telco’s underlying fixed costs are declining were positive.

Telstra’s ability to harness cost savings is the key to a share-price re-rating. Rising competition in fixed-line broadband – Optus has increased its market share in NBN add-ons due to aggressive broadband offers – will limit Telstra’s capacity to fill its earnings hole through revenue gains. It needs to crank up cost savings, and appears to be doing a good job.

At $3.42, Telstra looks fully valued against an average share-price target of $3.38 based on the consensus of 15 broking firms. Macquarie values Telstra at $3.70; Morningstar at $4.60.

I’m not that bullish, but after almost halving from its high, Telstra is pricing in a lot of bad news.

For all its problems, Telstra has a leading market share in all key telco segments, a significant competitive advantage via its mobile and wireless networks, good management and plenty of capital. An expected dividend yield of 6.4%, fully franked, is another attraction.

Telstra

Source: nabtrade

 

 2. Mid Cap: TPG Telecom

The market could not get enough of the star telco when its share price soared from $2.60 in early 2014 to almost $13 in mid-2016. Investors loved TPG Telecom’s aggressive disruption of the telco sector, bold acquisitions and rapid earnings and dividends growth.

Then the party stopped. Abruptly. TPG shares tumbled after lower-than-expected guidance in September 2016 and warnings that the NBN will squeeze profit margins, as it will for Telstra.

TPG’s dividend cut, a feature of the telco sector, compounded the pain. TPG shares slumped to $4.87 last month – a massive fall from grace for a company that once could do no wrong.

TPG has rallied to $5.89 after reporting a slightly better-than-expected result. Is that a turning point for the telco? The market thinks not. A price target of $5.74, based on the consensus of 13 broking firms, suggests TPG is fully valued after its latest price gains.

There is no shortage of risk for TPG. The NBN rollout will pressure earnings and TPG has taken a gamble with a $1.26 billion investment for a piece of the nation’s 4G mobile spectrum and plans to cover 80% of Australia’s population with a $600 million, three-year build.

TPG is a formidable disrupter. But the mobile segment is crowded and incumbents, such as Telstra, Vodafone and Optus, will not give up an inch of ground without an almighty fight. That said, mobile is a huge, growing market with attractive margins for TPG to exploit.

At $5.89, TPG is on a forecast Price Earnings (PE) of about 15 times FY18 earnings, based on consensus earnings. It is not screaming value, but the multiple seems reasonable for a company with long-term growth prospects, provided investors can tolerate continued volatility in the telco over the next few years as the market looks for signs that the worst is over.

TPG will need a lot of customer growth in the mobile market to make its $2 billion network investment pay off. It may look to acquire customers to speed things up.

TPG Telecom

Source: nabtrade

 

3. Small Cap: Amaysim Australia

Amaysim’s 1.07 million subscribers would boost TPG Telecom’s customer base and provide another low-cost channel to keep customer numbers ticking higher.

Like TPG, Amaysim shares have been volatile. The online telco provider raised $207 million and listed on ASX in July 2015 through a float at $1.80 a share. The price initially soared, then the mobile-services operator tanked to $1.50 in February 2015 after reporting disappointing revenue and customer growth.

An unexpected downgrade to prospectus subscriber forecasts – a no-no for any IPO so soon after listing – dented the market’s confidence and Amaysim struggled to get back above the issue price. It has since rallied to $2.

As a reseller of the Optus spectrum, Amaysim has lower margins and faces cut-throat competition, which includes retailers such as Aldi that sell phone plans. It looks like a basic business in a highly commoditised market – and one to avoid.

But Amaysim has some interesting strengths that the market is beginning to recognise. The company’s online model allows it to acquire customers at a fraction of the cost to big telcos and by leasing mobile spectrum off Optus, Amaysim has a relatively capital-light business model compared to telcos that must invest in and maintain networks.

As customer numbers grow, economies of scale improve. Amaysim’s EBITDA margins are rising and it is potentially a very profitable business as scale is built.

The company is growing quickly: revenue rose 29% to $326.7 million for FY17 and underlying earnings jumped 23% to $43.5 million. Subscribers grew 11%.

Amaysim’s business model is potentially highly profitable as it gets faster traction in subscriber numbers and cross-sells more products, such as energy policies.

At the recent Annual General Meeting, management said Amaysim’s performance, across all divisions, was solid and in line with expectation so far in FY18.

A handful of broking firms that cover Amaysim have a consensus price target of $2.26 (the sample is too small to rely on). The stock is due for price consolidation after recent gains, but looks well placed as competition in the mobile-phone market goes up another notch.

Amaysim will have plenty of room for growth – and potential suitors in the next few years – if its strategy succeeds.

Amaysim Australia

Source: nabtrade


About the Author
Tony Featherstone , Switzer Group

Tony is a former managing editor of BRW, Shares, Personal Investor, Asset and CFO magazines and currently an author at Switzer Report. He specialises in small listed companies, IPOs, entrepreneurship and innovation and writes a weekly blog for The Sydney Morning Herald/The Age on small companies and entrepreneurs.