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Investing in Australian Telecoms

Telecommunication has been a major growth industry as our use of smart phones, watches and other devices has grown.  So how can you invest in this sector and is it even a good idea?


 

ASX listed stocks in the telecom sector include two from New Zealand but this blog focuses just on vertically integrated Australian providers like Telstra, TPG and Vocus.  Our telecom sector is now undergoing huge change as the copper wire network Telstra previously owned is being replaced by the national broadband network (or NBN), owned by NBN Co.

Now the business models of all Australian telecoms must change and profit margins in broadband are expected to fall significantly – almost halving.  As Telstra no longer owns its large copper wire network asset, it will lose this source of profit. The Government owned NBN will lease their fibre network to all the telecom resellers, including Telstra.  So all previous network advantages are minimised and they are all now really re-sellers, as we face a competitive era of ‘telecom wars’.  Good for consumers, but tough for the telecos.

Telstra dominates Australia’s telecom industry with 49% of the subscriber market in domestic landline, mobile and broadband services. Its mobile business benefits from a network quality advantage that underpins its position. But now, government investment in the NBN is changing the fixed broadband market. Having sold its network asset, Telstra is now just a re-seller despite its dominant market share and scale advantage. The challenge for Telstra is how to offset its loss of revenue of about $3 billion a year as they fight off competition. It does have conservative borrowings and a capacity for improving productivity to replace lost earnings as it demonstrated with its shrinking fixed-voice and Sensis decline.  Growth in Telstra’s Network Applications and Services (NAS) may offer some offset but TPG’s entry into the mobile market will intensify competition, making recovery of Telstra’s lost revenue recovery more difficult. Telstra’s revenue breakdown from its 2017 annual report is shown below:

TLS product sales

To fight off the looming marketing challenge, Telstra has reduced future dividends to 70% of its underlying earnings with dividends now 30% lower than last financial year.  Its forecast dividend of 22 cents for the 2018 year equates to a gross (including franking) yield of 9%, well above the market, though its business will change markedly as the new NBN unfolds.  Telstra can potentially dominate innovative telecom markets but it may be constrained by its traditional culture.  It still has scale advantages with main revenue strength in mobile and broadband – but both have been losing earnings and may be hard to stop.  Telstra’s share price has been declining, rather than prospering on technology-driven growth.  At what price will it be low enough to be a compelling buy?  It may be getting close… but like the grocery wars, the telecom wars may be only just beginning.

Vocus has an extensive fibre and data centre network with a focus on telecom services for corporate customers.  In February 2016 it merged with M2 – a sales oriented, consumer focused telecom with minimal infrastructure that had grown quickly via many acquisitions. Consequently, Vocus is now a full-service, vertically integrated operator that can acquire market share in all Australian and New Zealand telecom sectors. The challenge lies in integrating and smoothly operating the merged businesses.  Recent boardroom dissention, disappointing trading updates and the challenges of the evolving NBN create risk for Vocus.  Its share price has more than halved in the last year and there are not yet signs of reversal but it does have potential.  Recent failed bids for the company suggest that management would sell at a good price should the opportunity presents itself.  Is there enough reason for confidence to buy now?

TPG Telecom is the price leader in the market, a strategy that delivered strong organic market share gains over several years. TPG generates solid free cash flow, and seems well placed in the long run for NBN-driven structural change. However, in the short term as its profit margins decline, it also has high capital spending on mobile networks in Australia and Singapore.  That capital outlay will suffer from the delay in the resulting revenue benefit, indeed they may seek a ‘roaming’ arrangement with another network (maybe.  TPG has the advantage of not needing to maintain old technology (3G) mobile tower sites. Overall, their lowest cost provider position may translate into a significant gain in market share during the pricing war as people change to NBN.

Continuing growth in its corporate division at increasing profit margin could offset other NBN related profit pressures.  TPG’s entry into the mobile network arena will also help limit NBN’s impact longer term, but it will be costly and involve execution risks amid fierce competition.  Though it seems well placed and has been a well managed company, this delayed mobile revenue means TPG may take years to justify the patience of shareholders buying now.  Will the capital it is investing to transform its business and mitigate NBN impact, enable it to improve its competitive position with new growth opportunities?

What to do?

Which of these has the most potential?  Do you buy less than your usual full weighting in these now, then add at low spots as the telecom price wars evolve?  Or is it better to just wait until the worst is clearly over?  Often the best prices turn out to have been when there only seems to be downside ahead.  Is that now?

Another game changer on the horizon is 5G mobile communication technology, which offers super-high speeds (~1Gbps).  This may undermine NBN’s appeal, though limited 5G capacity may come to NBN’s rescue.  A side benefit of 5G is that it uses less power so batteries may hold their charge longer.  Auctioning the 5G spectrum may begin in 2018, which will increase capital expenditure costs for mobile network operators. Is it possible there’s enough uncertainty right now for telco share prices to be oversold, if so, which stocks… or is there worse to come?

If you would like to discuss the information in this article or your investment options with one of our wealth management professionals, get in touch today!

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Disclaimer: All information in this article is intended to be general in nature for discussion purposes only. So you should not rely on it and seek personalised professional advice before making any decision.