TPG tipped to recover as mobile competition eases: Reporting season roundup

-- | 09/09/2021

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Emma Rapaport: Brian, the media loves to talk about themselves. So let's talk media companies. You cover several of our major media companies, Nine, News Corp, Southern Cross Media. Can you give us a sense of what they reported during reporting season and how they fared through the COVID crisis?

Brian Han: Yeah, during the reporting season, I think there's several things to point out there. Number one is that the advertising market is definitely rebounding. As we speak, the market is up between 20% to 30%, depending on which main media you are talking about, and that's after growing 30% to 40%, in the June half. So you can say that the recovery is well underway from COVID lows. And the second highlight from that is that I think the earnings leverage from their top line recovery is coming through really strongly, so much so that I think company balance sheets are largely repaired, right across the sector and management are actually talking about M&A, and consolidation. So, that's the lay of the land as we speak.

Rapaport: Why have advertising numbers come back so strongly?

Han: It's more of a baseline effect, because last year, obviously, in the first half, the June half, we had the initial impact of the pandemic, which was quite severe. So when the ad market was down 40% to 50%. So you're comparing it against bad prior periods. So obviously, there is that snapback from that. But then you talk to all the advertisers and the marketers out there and the confidence is persisting, even though we have a lockdown in two of our biggest states in Australia. I think that marketing and advertising confidence is persisting at the moment, and that they're learning to live with this pandemic. And in certain sectors such as TV, this has actually been quite beneficial because you and I and everybody else are locked up at home, and what else can you do at home apart from watching screen. So digital advertising and TV related advertising is actually doing quite well because of that.

Rapaport: So Brian, we just spoke about some of the highlights from the media sector, but were there any misses or lowlights that you saw across the month?

Han: Actually, the advertising recovery is such that misses were actually few and far in between. I think, as we speak, the only risk that I see right now is lockdown in both New South Wales and Victoria, because that could have a real disruptive impact on the all-important December quarter trading as we head into it. And if this keeps going on, that could really start to impact advertisers sentiment or marketer confidence going into the new year. Now, given how generally elevated stock prices are in the media sector, I don't think it will take much for those stock prices to go the other way, if we sense that marketer confidence is going to get rattled by all these lockdowns.

Rapaport: So let's talk quickly about one of your best ideas within this sector, even though you say a lot of them are overvalued. On the best ideas list is Southern Cross Media - they own several regional TV and radio networks. Can you give a quick summary of their result? And why you think the market is undervaluing them?

Han: Yeah, so you are correct. That is probably our top pick in the media sector it's trading at around 40% discount to our $3.50 fair value estimate. Now, the most recent results show that the earnings recovery is underway for both radio and the regional TV business. So much so that the balance sheet is at its strongest ever for the company and dividends were actually reinstated. So at the current price, the stock is I think trading at a fully frank yield of about 5%. And I think that's a decent compensation for shareholders to wait for the longer-term earnings growth to come through. Because on our estimates, we think this company can grow its EPS on average, by about 8% a year for the next five years. So that's not bad for a stock that's trading at PE of only about 10 times.

And then as you said right at the beginning Emma this company is predominantly a radio company 80% of group earnings comes from radio, and this company dominates that sector. And this radio industry, believe it or not, despite all these digital disruptions, has proven to be quite resilient to digital disruptions when you compare it to say, TV, or newspapers. And so those are the reasons why we're quite bullish on Southern Cross at current prices.

Rapaport: Let's switch quickly over to your other sector - telcos. Similarly, can you just give us a quick overview of some of the major results from the sector?

Han: Yeah, sure, this may take, perhaps a little bit more talking about because I think generally, number one, I think the sector proved its defensive reputation in the last reporting season, I think it delivered earnings. Earnings might not have shot the lights out, but they were resilient enough to continue to deliver on the dividend front. And I think balance sheets are generally strong right across the board. And as you know, their services have kept our working from home economy going during these lockdown times. And it will be I think, more of the same in the near term, because their earnings guidance for the next year, they were pretty much in line with what we were looking for going forward. But I'll tell you what the most important thing is, is I think one of our key investment thesis, is clearly coming through. And that investment thesis is this, we've long said that we think competitive intensity in the mobile industry will ease and that is definitely coming through after three years of unprecedented discounting in the market.

So we are seeing mobile prices increase right across the board. And we are seeing 5G really take traction in terms of giving consumers more value for more money. And we are seeing some discipline coming back into the market in terms of all the operators trying to extract adequate returns on all those 5G investments that they have sunk into the market. Now, on top of all of that, one good thing is that the NBN damage, I think we are now over the worst of it. So that going forward, there is really little incremental extra damage from that whole NBN. In fact, you can now probably look the other way and say, we can now see these operators using 5G to actually steal back some subscribers from NBN, on to their fixed wireless network using 5G as the basis.

Rapaport: So, not a best idea. It has come up to fair value, but how does Telstra fit within this scenario?

Han: Yeah, you are correct. I think this is the first time in about three years that Telstra is not our top pick in the sector, because as you said, I think it has rallied. And I think it's only about 5% below our $4 valuation. But when you actually have a look at the result and the implications from it, I mean, things are looking quite rosy. I mean, I guess that's why the stock price is improving. But the thing I say about the result is the result itself was unremarkable. But when you actually disaggregate the results, the composition of the result, and the quality of the result was quite encouraging. I say that because mobile division, which is more than 50% of group earnings. In the June half, it actually grew earnings quite substantially. And it grew its margins quite substantially, which goes back to that original thesis that we had, that we think competitive intensity is definitely easing. And Telstra is actually benefiting from leveraging its 5G leadership in terms of getting people to pay more for their services.

And the second thing was, the free cash flow generation from Telstra was just remarkable in that fiscal 2021. And the importance of that is that I think the days of worrying about whether dividends can be sustained at current levels, I think those days are probably over. And there probably could be upside in terms of dividend growth over the medium term. So, as you say, the rally in the stock price has brought it to our fair value. But the obvious question is, should shareholders continue holding it. And I think my answer is definitely, because as I said, the mobile competitive intensity is easing. I think one thing about this is, I mentioned before about the free cash flow generation. And then on top of that, as we know, they are doing a lot of asset splits and monetization. You know, a few weeks ago, they monetize their towers portfolio at a really ritzy multiple. And there's two or three other vehicles in line do similar things. So when you consider all of that I think there are near term catalysts to perhaps even shoot the stock price above and beyond our fair value in the near term. I mean, that is possible. So yeah, we're certainly not saying that people should rush out and sell their Telstra shares.

Rapaport: So,Brian, for investors that are looking for opportunities in the telco sector, you have referred to TPG, within the best ideas list. They've had an interesting year, because of their merger with Vodafone. So can you walk us quickly through why you think this stock is a best idea?

Han: Yeah, so the first reason is, it is by far the cheapest stock in the telecom sector, I think its trading at around 15% discount to our $7.40 fair value estimate. That's the first thing. The second thing is one of the headwinds has been that NBN damage, losing their own broadband subscribers to the NBN. And having seen their margins being decimated by that, but they only have about $60 million of profit left to lose to the NBN. And that's only about 3% of total group earnings. So that headwind is really diminishing. The second thing is that whole thing about easing intensity in mobile competition, and that will benefit from TPG because as you alluded to TPG and Vodafone merged about a year ago. And so now mobile is now more than 50% of TPG's earnings.

So they'll get that real earnings leverage from that recovering industry dynamics that I was talking about before. And then on top of that, is still getting impacted by COVID. Because it's lost basically all of its high margin roaming with travel dependent revenue. But to offset that, there's about $70 million of synergy to come from that Vodafone merger this year. And then next year, there might be additional $70 million to $80 million of synergy upside from that merger. So when you roll that up, I do feel that the 15% discount to our fair value estimate is perhaps too excessive, if you want to take a bit of a longer-term view of this stock.

Rapaport: Thank you very much for joining us. Hopefully next time we do reporting season, we'll be doing it from the office.

Han: Thank you, Emma. It was my pleasure.

This report appeared on www.morningstar.com.au 2022 Morningstar Australasia Pty Limited

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