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Why we see value in Telstra

 

Why we see value in Telstra

In this week’s video insight Tim discusses our view on Telstra. We have been reasonably critical of Telstra over the years, although given the extent of the share price decline we think Telstra has now reached a point in which it offers value upside.

The Montgomery Funds own shares in Telstra.  This video was prepared 28 May 2018 with the information we have today, and our view may change. It does not constitute formal advice or professional investment advice. If you wish to trade Telstra you should seek financial advice.

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Tim joined Montgomery as Head of Research and Portfolio Manager of The Montgomery Fund in July 2012. Prior to this, Tim was an Executive Director in the corporate advisory division of Gresham Partners, where he worked for 17 years. Before joining Gresham Partners, Tim worked for McKinsey & Company for four years, where he was involved in strategic consulting in both Australia and Denmark.

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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17 Comments

  1. Long term bets in the telco space cannot ignore the possibility of disruptive technology emerging. And the probability of this happening increases with time.

    Elon Musk’s SpaceX Starlink project is based around the idea of deploying a large number of low orbiting nano satellites to cover the earth. The latency in communicating with a satellite orbiting at about 1000km is much less than when communicating with a geostationary satellite at 35000km, resulting in higher throughput especially video etc. Richard Branson’s Virgin Orbit has similar ideas.
    Any successful project of this nature will sink the NBN ( which was flawed for all sorts of reasons from the beginning anyway ) and highly impact those who rely on it.

  2. You might have a look at Macquarie Telecom.

    In this case you have a high quality Data Centre business with strong focus on Government contracts, which is not just colocation, buried inside a telco business. If you use the nearest listed peer for the DC business which generates less revenue MW and do a SOTP then you can see upside, add in the tight register of instos/insiders and a liquidity event/funding event for the new DC….

    Turn the Macquarie Telecom share price upside down and it looks like Telstra…

  3. SOTP comes up with around $2.70 for core business, based on global peer multiples, and then add in the NPV of the residual cash flow from NBN, so $3 is feasible.

    Unfortunately the Fixed business still has a $1 billion in EBITDA to lose (assume cash EBITDA and ignoring capitalised amounts), – assume NBN average ARPU $75 x 50% market share at best double digit margins of 10%, and the roll off of the PSTN customer base at legacy PSTN margins.

    So you roll out another 1 billion at 5x multiple and you end up with another 40 cents or so off the $2.70 core in 2021/2022 gets to $2.30 plus the NBN cash flow and you get to about todays price when discounted it back to today and adding the dividend flows.

    Yes there is some property sales to come but this is fairly opaque.

    In the absence of the sector re-rating (not sure how) there is little here to get excited about but I can see why value investors would be emotionally drawn to Telstra given it’s price fall, but so they were drawn to Salmat and look how that turned out.

    Better off doing the work on TPG, if you understand the industry you will have an easier time working out a path to growth with this one.

  4. Thanks for your comments Tim.

    Currently there are many analysts with a price target over $3.00 , but even after lowering my RRR to 9% and lifting dividends post NBN rollout to 18 cps and reducing the growth rate to a more acceptable 2.5% results in a DDM valuation of $2.77 – that’s almost identical to my previous estimate but is based on more realistic assumptions. So, you “maybe” correct in saying that value is emerging at current prices, but there is no margin of safety built into current prices. I still think there is a reasonable chance of the stock falling lower going forward – those who hold Telstra should enjoy the high fully franked dividends while they last. The upcoming Telstra update in June might shed more light. It’s now basically a Dividend stock with a dubious growth outlook and I’m a little surprised that you would be attracted to such a stock when you normally target Stocks that retain earnings.

  5. Thanks Tim, as a Montgomery and MOGL unit holder I continue to have confidence in you and the rest of the team. Some food for thought though, from Telstra’s 2004 annual report:

    “BigPond remains Australia’s largest ISP “
    “We continued to focus on cost control in fiscal 2004. Overall expenses decreased by 7.7% to $15,487 million from $16,772 million in the prior year.”
    “Return on average equity – 2004: 26.8% (2003: 23.2%)”
    “The deployment and uptake of 3G mobile networks will further promote revenue”
    “Qantas have outsourced the management of their technology infrastructure to Telstra… This is one of the largest managed technology and communications contracts in Australian corporate history”

  6. Hi Tim

    Based on ” my ” DDM valuation estimate, it appears the current share price of $2.80 implies a future growth rate of 4.6% if your required rate of return is 10%.

    I have based my valuation on the following numbers.
    – Current Share price $2.80
    – Required rate of return 10%
    – Interim Dividend ( excluding special dividend) 7.5 cps – 15cps pa.
    – Dividend Yield 5.4% pa (excluding special dividend & Franking Credits)
    – Implied Dividend Growth rate post NBN rollout – 4.6%

    DDM Valuation 15cps / (10% – 4.6% )
    = $2.78

    Will Telstra achieve 4.6% Growth in Dividends post NBN rollout ??? If it can then the current price of $2.80 is justified considering a special dividend of 7cps pa is also currently paid. If the 4.6% growth does not eventuate post NBN rollout, then $2.80 is expensive – time will tell – it all depends on sustainability of Dividends and growth rate going forward. It’s a stock I’m still very cautious about as it’s past history does not leave you feeling confident that management can deliver that level of growth. I purchased into the first tranche and sold for a decent profit but haven’t owned it since.

    • We’re not at 4.6% Max, but we do think a lower discount rate can be justified, particularly having regard to the risk attaching to nbn co receipts.

  7. dane campbell
    :

    Do MFM foresee a fundamental shift in the way in which telstra utilise it’s earnings? Or don’t? Will mum and dad have to look elsewhere for a divi stock in their pension?

    • TLS has announced a change in dividend policy. Where previously they paid out close to 100% of earnings, going forward they intend to pay 70-90% of recurring earnings and a smaller percentage of 1-off nbn receipts.

  8. TPG is about to do some serious damage to Telstra’s mobile network in the next few years.

  9. Hamish Douglass
    :

    Since when is TLS an A1 business? Have youse lost the plot or is this just symptomatic of holding too much cash and missing the bull run over the past few years?

    P.S. you’re probably right TLS is due a pop but this article just represents such a process change to what I understood Montgom was about that it has me questioning everything I thought I knew…

    • Hi Hamish. In relation to process, I suspect your ‘A1′ question is a reference to Skaffold quality scores. Skaffold is a different business to Montgomery Investment Management, and it is not something that we use. When it comes to business quality, we make an assessment based on analyst judgement of mainly qualitative factors like: industry structure, pricing power, switching costs, capital intensity, market position etc., and importantly, we try to make it forward-looking.

    • Hi Dave. If you look only at its history you would conclude otherwise. However, we think the future could look quite different to the past. TLS has a dominant market position in an industry where scale is important; it is on the path towards achieving an efficient cost structure; and if we are right about strong growth in mobile use cases in a 5G world, then it starts to look like a different proposition. There may well be some more pain ahead as the nbn migration runs its course, but we anticipate profitable growth over a longer timeframe.

  10. The comment about autonomous vehicles is especially interesting. In a sense the word ‘autonomous’ is wrong because in actual fact such vehicles/and related systems require a complex communications network – involving numerous senses and feedback loops – on a scale we have not seen before. Telecommunications networks such as 5G will be the key to this operation and companies that have this infrastructure in place and the expertise to develop will be well placed to grow.

    John

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