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Does MTU Offer Value?

Does MTU Offer Value?

Telecommunications supplier M2 Group (ASX: MTU) is a business we have previously owned in The Montgomery Fund, and it was a rewarding experience. MTU shares rose from around $3.50 when TMF was launched in August 2012, to over $6.00 in August 2013. We parted ways with MTU at that time, as the full-year results announcement showed that MTU’s debt-fuelled acquisition strategy had stretched its balance sheet beyond the limits we consider to be investment grade.

The share price has weakened slightly since then, so we missed nothing by sticking to our process. Nevertheless, we continue to monitor MTU so that when it recovers its investment-grade ranking, we will be up to speed on its investment merits. MTU is aiming for 30 per cent EPS growth this year, so it certainly shows strong growth potential, and it’s strong growth that will help bring its balance sheet back into shape.

When we caught up with MTU recently, the commentary seemed fairly positive. Some recent product initiatives have been well-received in the market, including a self-install cloud offering aimed at small business, and an energy resale offering which MTU bundles with telecommunications services and sells to small businesses under the well-regarded Commander brand. In the case of this latter product, MTU claims to have a significant structural cost advantage over the large incumbent energy retailers.

Combined with healthy organic growth delivered in its consumer business, these sorts of initiatives look to be driving MTU towards another good result for FY14. The company has issued guidance for underlying NPAT of $85-$95m for the year, but here is where it gets a bit interesting. Underlying NPAT excludes $15m of amortisation of customer contracts acquired through M&A. If you include this amortisation, NPAT falls to $60-70m, so it’s important to be clear on which number is the “right” one. At $85-$95m, MTU looks cheap; at $60-$70m – it doesn’t.

According to Bloomberg, broker consensus has FY14 NPAT at around $80m – somewhere between the two. It appears the broking community may be divided as to whether to include or exclude the amortisation.

For us, amortisation of customer contracts is a non-cash accounting charge that would not be there if the customers had been acquired organically. Accordingly, we see a strong case for ignoring it provided MTU does a reasonable job of integrating the acquired businesses. On this basis, there may be good value currently on offer in MTU, but don’t forget – that debt still needs to be reduced to bring the quality of the company up to scratch.

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Tim joined Montgomery in July 2012 and is a senior member of the investment team. Prior to this, Tim was an Executive Director in the corporate advisory division of Gresham Partners, where he worked for 17 years. Tim focuses on quant investing and market-neutral strategies.

This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.

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4 Comments

  1. Post VOC merger, the debt levels still look like they will be very stretched – would love your thoughts on these numbers as otherwise this looks like a great company to hold if they can get the debt under control.

  2. Hello Tim : as a holder of MTU, I’d be interested in your latest views on MTU, and whether you think it is on the right track to improving quality and performance. My review using Skaffold shows the company in this past reporting season did as they told Paul they would do. Reduced debt by around $30m ($312m to $295m), and thanks to good cash flow also increased cash in bank from $22m to $41m. Net debt to equity improved from 92% to 76%. Appreciate anyone’s comment on this one.

  3. Paul Middleton
    :

    As an investor in the stock, I too am vigilant regarding the debt levels. Having observed a rise in net debt in !H2014, I contacted management and queried them on when they expected to start paying down the debt. The response was that they are planning to reduce debt by $30m per year. Let’s see what happens in 2H2014.

  4. carlos.cobelas.1
    :

    Everyone is entitled to their own opinion, but I know several people who have told me that Dodo is the most frustrating compnay they have ever dealt with and would not recommend anyone use them.
    This was one reason I sold my MTU shares, the other being their very high debt level.

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