Why the Vocus share price can race ahead later this month

Its larger rivals have been stealing the spotlight from the Vocus Group Ltd (ASX: VOC) share price. But this may be about to change this month.

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Its larger rivals have been stealing the spotlight from the Vocus Group Ltd (ASX: VOC) share price. But this may be about to change this month.

This is the prediction by Morgan Stanley, which is tipping a re-rating in the telecom services group's share price when management provides an update in June.

If that comes to pass, it will be Vocus' turn to have its 15 minutes in the sunshine. Investors are preoccupied with the merger of TPG Telecom Ltd (ASX: TPM) and Vodafone Australia, and the impact of that on the Telstra Corporation Ltd (ASX: TLS) share price.

Debt and earnings update

The cloud hanging over Vocus is the state of its balance sheet. Management is scheduled to provide an update on the refinancing of its $1.1 billion debt facility before the end of the month.

Morgan Stanley believes it will use the opportunity to update the market on its underlying earnings before interest, tax, depreciation and amortisation (EBITDA) guidance too.

Vocus reiterated its FY20 EBITDA forecast of between $359 million and $379 million back in February at its half year results announcement. This compares to the average broker estimate of $367 million.

"For perspective, the last time VOC refinanced their debt, in Apr 2018, VOC shares rallied +21% over the next three weeks (vs. XJO +4%), as the risk of an equity raising was reduced," said Morgan Stanley.

XJO refers to the S&P/ASX 200 Index (Index:^AXJO).

Best outcome

There are three potential outcomes from the upcoming Vocus update, according to the broker. Firstly, Vocus will successfully refinance its debt and reaffirm its EBITDA guidance.

This will lift market confidence in both its financial health and FY21 outlook with consensus pencilling in a $388 million figure.

Two other scenarios

The second scenario sees debt refinanced but the EBITDA guidance lowered by 2.5% to the midpoint of management's guidance. This outcome will provide certainty on the group's balance sheet but slightly weaken confidence in its FY21 outlook.

Under the third scenario, Vocus will launch a capital raising and downgrade its EBITDA guidance by 5%. This will see shareholders diluted and consensus downgrading forecasts for the next financial year.

Re-rating opportunity

The first scenario is the most bullish one and Morgan Stanley believes the stock will jump 13% from yesterday's closing price of $3.10 to $3.50.

The broker believes this is the most likely outcome because management made good progress in turning the business around since the last refinancing exercise two years ago and there's less earnings risk given this is the last month of FY20.

If there was bad earnings news, one would think the company would have already announced it due to the continuous disclosure obligation.

Worst case doesn't look so bad

But even under scenario two, the impact on the Vocus share price may not be as bad as you'd think. The broker thinks the stock could also climb higher to $3.30 a share as that puts it on a price-earnings multiple of 18 times.

In the last and most bearish scenario, the stock is tipped to fall to $2.55.

However, I would point out that ASX companies that have undertaken a capital raise in the midst of this COVID-19 pandemic have outperformed after the raise.

So even if Vocus goes cap in hand to shareholders and the share price falls, this could also prove to be a buying opportunity.

Motley Fool contributor Brendon Lau owns shares of Telstra Limited and TPG Telecom Limited. The Motley Fool Australia owns shares of and has recommended Telstra Limited. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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