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Telco shares tumble as competition intensifies

Nicki Bourlioufas  |  28 Sep 2016Text size  Decrease  Increase  |  

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As shares in telecoms providers have taken a hit due to heated competition in broadband and the rollout of the NBN, now may be the time for investors increase their exposure.


TPG Telecom (ASX: TPM) shares have tumbled recently as competition ramps up in the broadband market, and Vocus Communications (ASX: VOC) and Telstra (ASX: TLS) are suffering too as margins come under pressure with the rollout of the National Broadband Network (NBN).

For consumers, it's a buyer's market, as the nation's telcos offer cheaper and cheaper broadband packages to lure new customers, and perhaps for investors it's also the time to buy into a telco.

TPG's share price last week plummeted to $8.63 after the company announced disappointing 2017 earnings guidance. TPG shares are trading well below their year high of $12.93.

The company said its underlying earnings before interest, tax, depreciation and amortisation (EBITDA) rose 60 per cent to $775.3 million for the year to 31 July, broadly in line with consensus expectations.

However, for the 2017 financial year, TPG forecast underlying EBITDA of between $820 to $830 million. This was below market expectations by about 7 per cent, driving the stock lower.

"I do think the reason TPG fell so hard is that it was very expensive to start with, so it went down by around 25 per cent, rather than the 7 per cent their forward earnings were downgraded by relative to market expectations," said Brian Han, Morningstar's telecommunications analyst.

"However, there is no change to our $10.00 fair value estimate per share, one that we believe already adequately accounts for the increasing competition in the telecom market."

But Han is still cautious on the stock.

"It is still not attractive enough for us to fall in love with TPG shares, but our affection is rising."

Several other analysts have downgraded the stock to a hold, or underperform, and have cut their price targets.

Following TPG down last week too was Vocus Communications, which dropped to a year low of $5.62, well down from its year high of $9.40. Like TPG, Vocus was vulnerable to a sell-off as the shares were trading at a high earnings multiple.

Han has an $8.50 fair value estimate on Vocus. "As such, shares in Vocus are now trading at an attractive 26 per cent discount to our intrinsic assessment."

Han is more upbeat on Vocus than TPG and said it is less vulnerable to competition as the NBN is rolled out, as the latter has a greater number of higher-margin customers that may be impacted than Vocus.

"We believe the NBN's impact on Vocus is relatively limited (a potential EBITDA hit of around 7 per cent) because only around 20 per cent of its broadband subscribers are higher-margin 'on-net' and therefore directly hit by the higher cost of accessing customers as they migrate to the NBN. In contrast, a third of TPG's customers are on-net," he said.

"Vocus management's near-term goal is to increase Vocus' share of domestic broadband subscribers from the current 7 per cent to over 10 per cent. We see this as easily achievable, given the company is currently snaring 9 per cent to 10 per cent of new NBN connections every week."

Their main competitor Telstra too has suffered in recent weeks due to stiff competition. Han said the stock is trading well under his fair value of $6.00.

Concern about the NBN has depressed Telstra shares too, though the company is well placed to handle the earnings hole of $2 billion to $3 billion once the NBN is fully rolled out given its strong balance sheet and readiness to invest in new ventures to "plug the hole".

"In our eyes, subscriber inertia should still allow Telstra to retain a commanding market share," Han said.

As for Telstra's planned increase in capital expenditures over the next three years, "faced with a choice of acquiring or starting significant new ventures (for example, overseas or in noncore areas) versus investing in the domestic core franchise to plug this earnings hole, we would unequivocally prefer the latter".

"That appears to be what management has decided to do with the newly unveiled investment program, one that will future-proof its network infrastructure and maintain Telstra's market leadership."

So while he's wary of TPG, Han maintains a more positive outlook on Telstra and Vocus. While the latter is a growth stock and more volatile, Telstra is now delivering a 6 per cent yield to investors and still drawing the buyers.

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Nicki Bourlioufas is a Morningstar contributor.

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