The beaten-up telco sector is either an NBN laid value trap or offering investors some bargain opportunities at the moment, with leading companies Telstra Corporation Ltd (ASX: TLS), TPG Telecom Ltd (ASX: TPM) and Vocus Group Ltd (ASX: VOC) all trading at heavily discounted valuations compared to this time last year.
All three carry varying risk-adjusted profiles given their current valuations, with Telstra's scale meaning it's likely to remain a reasonable income play, although it's unlikely to deliver much growth in the years ahead.
Vocus on the other hand has some serious financial reporting and staffing issues after its recent merger and acquisition spree, which means it carries a lot of risk and is still heavily shorted by speculators betting it has more bad news up its sleeve. While it has some attractive core assets, I would wait until its next update scheduled for June 14, before considering it as an investment prospect.
That leaves TPG Telecom, which in my opinion offers investors by far the best risk-adjusted returns given its current valuation of $5.56 per share. Below are five reasons why I rate TPG as a buy today.
- TPG is founder-led with two insiders in founder David Teoh and institutional backer Robert Milner owning about two thirds of all the shares in TPG. The heavy insider share ownership means its founder can focus on the long term by investing free cash flows for growth, rather than paying out dividends to please institutional investors.
- TPG now has 5G mobile network capacity in Singapore and Australia which means it is well positioned for the future of communications and has the opportunity to win market share from larger rivals like Vodafone, Optus and Telstra in the lucrative mobile space.
- TPG's fibre-to-the-basement city-centre focused residential broadband business may start growing healthy profits in FY 2018 as the large amount of capex the business has sunk into it recently starts to produce a big return on investment.
- TPG's newly-acquired iiNet business is still lifting its profit margins, with plenty of room to run. This should help negate the margin-crunching effects of the NBN.
- TPG's fibre-optic communications and internet services to corporate customers PIPE Networks business is still growing nicely. This is no surprise given the exponentially growing demand for data and cloud services across corporate Australia, with the PIPE Networks retaining a strong outlook.
- TPG's valuation at $5.56 per share looks reasonable with the market selling the stock off based on reduced expectations for dividend payouts in the years ahead. This is because over the short term TPG will have to invest heavily in constructing its mobile networks in Singapore and Australia, among other investments.
TPG shares then are not for dividend seekers, traders, or inexperienced investors, but they might be for bargain hunters focused on long-term returns as the company invests for the future.
Of course TPG carries several substantial risks. Including the unknown margin crunching effects of the NBN, its substantial debt profile, regulatory risk, the competitive environment, and fast-changing communication technologies. This means a debt-funded growth business like TPG should only ever be a small part of a balanced investment portfolio.
