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Battle-scarred investors across the world are now faced with the increasing likelihood that Santa Claus will not be coming to town.  The probability of a Santa Claus Rally grows dimmer with each passing day, with no market-moving catalysts in sight on the horizon.

While many investors have fled to the safety of cash, the intrepid few plug on, wearily looking for places to park their investing dollars.  Traditionally, Telco Shares have been a favoured place to hide, since most had business models relatively bullet-proof in the face of economic downturns with the added advantage of dividend payments.

The advent of cellular communication changed all that and now even dividend paying telecommunications companies can qualify as growth shares.  While value investors look for sound companies at discounted prices, growth investors are willing to pay a premium price as long as they see the potential for substantial growth going forward.

In a world going wireless at breakneck speed, many telecommunication companies are poised to profit handsomely.  In Australia, we have the added opportunities stemming from the coming of the National Broadband Network (NBN).

The NBN will take 10 years to fully rollout bringing broadband communication to 97% of Australians.  That is an estimated addition of 1 million consumers.   Right now Australia’s telecommunications giant Telstra (TLS) is getting most of the favourable press coverage, but other companies in the sector might see significant benefits as well.

Most investors begin their search for shares with the venerable Price to Earnings Ratio.  Here is a chart for some Australian Telco shares offering growth potential, as well as growth at a reasonable price (GARP) in some cases.  

CompanyCodeMarket CapP/EP/EGROEDividend Yield
Amcom Telecom AMM210.3M13.13.8513.25.49
iiNet LtdIIN429.1M11.33.9416.14.14
M2 TelecomMTU356.4M11.21.4729.5%6.12%
Singapore TelecomSGT38.5B12.91.015.5%5.14%
Telecom New ZealandTEL3.1B11.8.6616.7%9.45%
Telstra CorporationTLS40.6B121.4526.8%8.56%
TPG TelecomTPM1.06B11.91.4215.2%3.83%

 

One commonly accepted measure of a growth share is a P/E over 15.  In fact, in the eyes of some, the higher the ratio the better.  By that standard, none of these shares qualifies as a true growth prospect.  However, P/E ratios for the Telco sector on average are 11.8 compared to 13.2 for the broader ASX 200.  

In reality, Price to Earnings Ratios in the Telco sector rarely reach the lofty heights of their cousins in Information Technology.  In terms of share price performance, however, the Telecommunications index (XTJ) is up about 7% in a dismal year with the ASX 200 XJO is down almost 10%.

Some of these Telco shares today should be attractive to a growth at a reasonable price (GARP) investor.  GARP investing is a hybrid strategy, combining in the eyes of many the best characteristics of value and growth shares.  

Perhaps the key indicator for GARP investors is the P/EG Ratio, with a P/EG under 1.0 signaling the share is underpriced.  A P/EG under .5 sends some GARP investors to dig into their pockets for spare cash to invest.  On this measure, 5 of our shares look promising, with one of those 5 sporting an enticing P/EG of .42.

Another metric favoured by both value and growth investors is Return on Equity, with an ROE above 15% as a benchmark measure.  Six of the seven shares in our table meet this measure, with the seventh not far off.  In addition, all have attractive dividend yields, with several beating interest rates available for cash deposits.

The missing ingredient from our table is historical performance.  With few exceptions, even the strictest proponent of growth investing sees historical growth as possible evidence of growth in the future.  GARP and Value investors also look to a minimum of 5 years of performance history.

It’s time then to drill down and take a look at the past.  Typically, investors look for 10% growth rates for smaller companies and 5% or more for larger companies.  We are going to look at five year averages for revenue, earnings per share, dividends per share, and return on equity.  Before doing that we want to pause for a moment and look at the pitfalls of jumping on the wagon of a rising star.

At the half year point in June 2011, the biggest share price gainers in the ASX Telco sector year over year were NWT (Newsat Ltd) up 142%; VOC (Vocus Communications) up 43.6%; and BGL (BigAir Ltd) up 34.2%.

Here is how the share prices of VOC and BGL have fared over the last six months, compared to the XTJ Telco Sector:

BigAir has managed to remain positive for the year while Vocus has dropped dramatically.  NWT is still flying high, up 100% at this point with a P/E of 408.2.  There is one analyst covering the company.  Even some hardened growth investors question the sustainability of that kind of P/E.  However, the argument in favour is compelling to many.  NWT, on the strength of its planned Jabiru Satellite Program, expects to reinvent itself as an owner of satellites instead of the reseller of satellite capacity, which is its current business mode.

This is a classic speculative investment based on hope the project will reach fruition and produce the growth investors now appear willing to pay for in the absence of one dime in revenue.  While the story may have a happy ending, we think there are safer growth opportunities in the Telco sector.

Now let’s look at those 5 year averages for our seven target shares:

 5 Year Avg Growth:
Revenue per Share
5 Year Avg Growth:
Earnings per Share
5 Year Avg Growth:
Dividends per Share
5 Year Avg
Return on Equity
2 Year Avg Forecast:
 Earnings per Share
AMM7.9%18.9%14.6%13.38%15.4%
IIN15.3%19.6%10.2%14.14%14.3%
MTU43.7%43.4%43.9%27.51%23.8%
SGT5.0%.9%18%17.34%10.7%
TEL-3.3%-15.2%-18%-28.6%15.5%
TLS2%.3%-3.8%29.34%8.3%
TPM-10.5%17.6%14.8%8.15%28.6%

 

It is rare that a clear leader emerges from this kind of comparison of historical performance.  However, MTU leads the pack in almost every category and is a close second in the all-important future growth forecast in EPS.  While lagging behind by a healthy margin, IIN posts impressive numbers, yet its share price movement does not reflect that.  For that matter, MTU’s year over year performance is hardly stellar, as you can see from the following chart:

As you know, perception is more important than reality.  For growth investors, the perception of future growth goes beyond the numbers into qualitative issues like market share and market potential.  So let us briefly look at each of these seven companies and see how and where they do business.

Amcom (AMM)

 

Chart: Share price over the year versus ASX200 (XJO)

Amcom is based in Western Australia and owns and operates a fiber optic network providing internet and voice services to commercial enterprises and government organisations.  They also manage data centers and provide cloud computing services.

The opportunity here is the quality of its fiber optic network.  It offers a combination organisations of all sizes desperately need – speed and security.  At the present time no one knows how the government plans to build out the NBN, short of the planned acquisition of Telstra’s existing infrastructure.  The risk with AMM is high since regulations could impinge some existing networks

iiNet (IIN)

 

Chart: Share price over the year versus ASX200 (XJO)

As the third largest provider of Internet services (ISP) in Australia, iiNet is in a position to benefit substantially from the NBN.  Currently they provide voice and data services via DSL to consumers.  Bundled plans offered by iiNet are gaining in popularity but there are many residential units throughout the country where they are currently barred from access.  The NBN is expected to increase competition by opening up the network to benefit even the smaller ISPs.  

The key risk to iiNet’s business is the growth in wireless communication.  As wireless technology improves, the demand for fixed broadband connections may suffer.

(M2 Communications) MTU

 

Chart: Share price over the year versus ASX200 (XJO)

M2 Communications provides Internet and other services primarily to small and medium sized businesses.  This retail side of their business is supplemented by a wholesale operation where they provide mobile, voice, and data services to Telecommunications resellers and small Internet Service Providers (ISPs).  

Their business model is somewhat unique in that they go beyond packaged services and offer customised solutions to fit the needs of their customers.  In addition, they have little infrastructure, instead using the existing networks of Australia and New Zealand’s largest Telco’s.  In effect, this model foreshadows what the NBN intends to do – allowing multiple providers to utilise the national network.  While the risk of increased competition is high, their experience with tailoring a full range of telecommunications services to specific customer requirements could put them in a solid position to maintain their customer base.  In addition, the availability of the NBN could give them access to customers currently out of their reach.

Sinagpore Telecommunications (SGT)

 

Chart: Share price over the year versus ASX200 (XJO)

Singapore Telecommunications is a Singapore based company with an Australian subsidiary, Optus.  SGT offers investors the opportunity to benefit from Telco services offered in emerging markets through the parent company.  Their presence throughout Southeast Asia gives them a decided advantage in dealing with companies that do business in these same markets.  With their existing offerings of data and voice services over both wired and wireless networks, their major risk to growth is a severe slowdown in global economic growth.  They anticipate India to be their major growth market.  

Telecom Corp of New Zealand (TEL)

 

Chart: Share price over the year versus ASX200 (XJO)

Although this company is the main telecommunications provider in New Zealand, they operate in Australia as well and are listed on the ASX.  They dominate the market in New Zealand with offerings ranging from fixed line services to broadband to voice and data to a variety of IT services for businesses.  New Zealand’s national broadband initiative has two parts – The Ultra Fast Broadband network (UFB) and the Rural Broadband Initiative.

Their rollout began in 2010 and is scheduled to be completed by 2019.  TEL has completed the split from its infrastructure network company – Chorus – and will be free to compete fully in the UFB playing field.  Their dominant market share and ability to offer bundled services should enable them to withstand increased competition.  While their position in mobile, broadband, and IT services is substantial, there remains significant risk of loss of fixed line voice telephone and other services.  In addition, increased competition may put pressure on margins.

Telstra (TLS)

 

Chart: Share price over the year versus ASX200 (XJO)

More retail investors own shares of TLS than of any other company in Australia.  They are our leading provider of telecommunications services and they do it all.  In short, they offer everything to everybody in the field – voice, data, broadband, IT, and on and on.  They have been a dividend powerhouse for years, although showing little growth over the last five years.  

Much of the hype from analysts about TLS relates to its dividend performance, which is now underpinned by the anticipated 11 billion dollar payment from the NBN for the acquisition of Telstra’s existing network infrastructure.  However, that deal is currently delayed.  As the NBN rolls out there may be other regulatory risks to TLS.  Despite its market share and handsome dividend, its opportunities for capital appreciation appear limited as evidenced by the 2 year EPS growth forecast of 8.3% – the lowest forecast among the 7 shares in our table.

TPG Telecom (TPM)

 

Chart: Share price over the year versus ASX200 (XJO)

TPG Telecom serves both consumer and commercial markets.  They offer telecommunications services to residential customers, small and medium enterprises, governments, and large corporations, mostly here in Australia. Their products include voice, internet, and data solutions over both a fixed line fibre optic network and a wireless network.  Their IT offerings have been supplemented with cloud computing services through a recent acquisition.

Another acquisition – PWK (Pipenetworks) – laid the foundation for significant growth with this company.  As the NBN rolls out, demand for increased international bandwidth is sure to follow and TPG will be right there with PWK’s submarine cable.  This cable will provide international transmission capacity between Australia, the United States, and Asia.

Their two major risks are the bundled services larger competitors may be able to offer with the NBN and pricing pressure from increased competition.  Note that of the 7 shares listed, TPG has the highest 2 year forecasted EPS growth – 28.6%.

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