Cheap or nasty? Seven, Nine and Telstra

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<p><strong>Glenn Freeman: </strong>I'm Glenn Freeman for Morningstar. And for this edition of "Ask the Expert" I'm speaking to Brian Han who's dialing in remotely. Brian, thank you very much for your time today.</p> <p><strong>Brian Han:</strong> Pleasure, Glenn.&nbsp;</p> <p><strong>Freeman: </strong>Now, Brian, amid the market sell-off that we've seen in recent days, a couple of stocks within your coverage, Seven West Media and Nine, have now dropped into 5-Star territory. But does this necessarily mean that they're bargain buys?</p> <p><strong>Han:</strong> Well, Glenn, I think that's a question that all analysts are grappling with, not just with those two stocks, but there are a lot of stocks. Now, they are bargain buys at current prices based on long-term sustainable fundamentals and earnings. However, the critical question is, can these companies actually withstand the current malaise and come out the other side to realize its fair value. And that's the risk that we're talking about, because some of these media companies are very indebted at the moment. And as you know, advertising conditions are very subdued at the moment and probably going to get worse because advertising, at the end of the day, it hinges on corporate confidence and it hinges on consumer sentiment. And those are two qualities that are really in short supply at the moment and probably going to get worse before it gets better. And therefore, with that advertising conditions in the doldrums, the pressure on the balance sheets and cash flow could be significant. And I think that is why the share prices have been marked down so severely because people are doubting whether these media companies' balance sheets can equip them to come out of these crises. And that is why there's that near-term risk that people or easily the market is not willing to take at the moment.</p> <p><strong>Freeman: </strong>And at Seven West Media, is it the same story. What's the risk there despite it being cheap at current prices?</p> <p><strong>Han:</strong> Yeah. So, if you're comparing Nine and Seven, I think Seven is even more indebted than Nine. In fact, when you think about it, Nine Entertainment's balance sheet is actually quite solid, one of the probably strongest in the sector. Seven, you probably can't say that. It was already very highly geared going into these crises, and that it's only going to get worse. And I think there is a view out there in the market that perhaps they might not come through this downturn without some sort of a balance sheet restructure.</p> <p><strong>Freeman: </strong>So, debt, you mentioned that debt, and that seems to be something that a lot of people are talking about. We're heading into a recession. It's companies with high debt, isn't it, that people really need to take a second look at?</p> <p><strong>Han:</strong> Exactly, especially, if I dealt in consumer discretionary sectors, those sectors that are right at the forefront of impacts of this virus. Because right now with everybody in lockdown, people are actually worried about livelihoods and they're getting the staples for their homes. They're not thinking about advertising. They're not thinking about going to theme parks. They're certainly not thinking about, you know, getting a Harvey Norman add-on TV and going out and buying a fridge. Perhaps maybe you should buy a fridge. But you see where I'm coming from.</p> <p><strong>Freeman: </strong>Or a freezer.</p> <p><strong>Han:</strong> That kind of environment &ndash; balance sheets of discretionary companies are probably the first and foremost concern for the market. Do they have the financial capacity and liquidity to survive this current turmoil? And we don't even know how long this turmoil will last for. It could be another three months; it could be another 12 months. So, that's the risk.</p> <p><strong>Freeman: </strong>Telstra has stayed relatively flat. And at current prices it's considered 4-Stars in Morningstar's view. How does that compare to, say, these other two companies that are within the same sector, this communication services that you cover?</p> <p><strong>Han:</strong> Yeah. So, in an environment like this people flock towards defensive investments. Now, everything is going down at the moment. But on a relative basis, you would have to say that companies like Telstra have more defensive earnings. Now, the narrative is very positive, people are working more from home and therefore the telecom needs will increase, their data needs will increase, and the capacity needs will increase. And that doesn't mean Telstra would make more money in this environment. In fact, they probably would make &ndash; (elect to) make the same amount of money. In fact, there will be pressure on their costs as they need to upgrade to provide more capacity and to maintain the network so that it doesn't get overheated by this current demand.</p> <p>But we are talking relativities here. At least with Telstra's earnings, we can have visibility &ndash; we have a line of sight to what they can earn over the next 6 to 12 months, which is more than you can say for most companies out there in the economy. So, therein lies the defensiveness of their earnings. And because those earnings are defensive, they can service their debt more comfortably than other sectors. And therefore, their balance sheet is stronger and that's where most institutional shareholders may choose to buy because earnings are more stable than most of the other sectors in the market.</p> <p><strong>Freeman: </strong>So, which parts of Morningstar research should people be looking most closely at in determining some of these things that you've been speaking about?</p> <p><strong>Han:</strong> Yeah, I think, ultimately, we come back to this moat, which we always talk about, moat as in companies with strong competitive positions which can survive the current malaise. And because they are stronger, when they come out of this downturn, whenever that might end, when they come out of this downturn, they will be even stronger because a lot of competitors were falling by the wayside. So, I think it is important to focus on those moat-rated companies that are trading at good discounts to our intrinsic assessments. Telstra is one. There are many other defensive sector stocks that are trading at 4 or 5 stars, and those I think will be the first port of call for investors.</p> <p><strong>Freeman: </strong>Thank you very much for your time Brian, and you keep well.</p> <p><strong>Han:</strong> Thank you, Glenn.</p>

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