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This telco stock is now trading at an attractive discount

Glenn Freeman  |  05 Dec 2016Text size  Decrease  Increase  |  

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Despite a share price slippage of almost 25 per cent in recent months, this corporate-client focused telecommunications company is a quality business that should overcome its transitory growing pains.


Vocus Communications' (ASX: VOC) share price slumped 23 per cent at the end of November, following management's disappointing guidance of between $205 million and $215 million in net profit after tax (NPAT) for fiscal 2017.

According to Morningstar equity analyst Brian Han, many of its current problems are akin to trying to juggle too many balls at once.

Having made a string of acquisitions since 2014, management is struggling to integrate five integrations, including Amcom, M2 and Nextgen, along with two New Zealand-based companies.

"We have certainly been guilty of underestimating this risk, with our EPS [earnings per share] forecasts trimmed by another 11 per cent to 15 per cent annually over the next three years," says Han.

"However, we see the negativity as reflected in the 11.6 times fiscal 2018 price/earnings ... as excessive," says Han, who describes the market reaction as a "shoot first, ask questions later" situation which drove the stock down almost 30 per cent in matter of days.

"Despite the disappointing update, Vocus is still guiding for fiscal 2017 normalised EPS growth in the low-to-mid-teen levels--against Morningstar's forecast 12.8 per cent."

Han believes there is still substantial quality in the underlying business, "as evidenced by the continuing momentum in corporate and wholesale and solid growth in consumer broadband". It holds a 10 per cent share of the new National Broadband Network (NBN).

"Despite its teething problems with integrating three recent large acquisitions, we believe Vocus is still generating solid organic growth, especially in the corporate fibre and Ethernet unit--one that enjoys juicy margins (40 per cent-plus) and return on invested capital," he says.

These issues, along with a boardroom split in October, culminating in two departures--executive director James Spenceley and non-executive director Tony Grist--"have opened up an attractive discount between Vocus Communications' stock price and our recently revised $7 fair value estimate".

"However, Vocus now has a unified board and a fully backed management team to drive the company longer term. In addition, synergies are still coming through, although the Nextgen acquisition is under-delivering on initial expectations," Han says.

Concerns raised around Telstra's (ASX: TLS) NBN earnings hole in September had also been flagged as a potential negative for Vocus.

"However, we believe the NBN impact on Vocus is relatively limited--a potential EBITDA hit of around 7 per cent," says Han.

"Furthermore, with just around 7 per cent of the fixed-line broadband subscribers in Australia, Vocus' strategy remains one of increasing market share, with the NBN rollout as a catalyst. Consequently, we see the current stock price discount to our intrinsic assessment closing over time."

While acknowledging the company has a long road ahead in earning back the trust of the public, Han is confident it will achieve this.

"We think they can. Fundamentally, it has very valuable, very hard infrastructure assets, and the salesforce to become a  major force in the Australian telecommunication space, especially as we head into the NBN and the digital age."

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Glenn Freeman is Morningstar's senior editor.

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