Australia | Jun 28 2006
By Chris Shaw
Telecommunications stocks may be on the nose thanks to regulatory issues impacting on Telstra (TLS) and Telecom New Zealand (TEL) and margin pressure across the sector, but analysts at SB Citigroup nevertheless believe junior player Commander Communications (CDR) is well placed to deliver long-term earnings growth that should provide a boost to its share price.
The broker stresses it remains a longer-term story though, as it has cut its earnings forecasts in FY06 by 17% and in FY07 by 12% to reflect a fall in profitability and higher integration costs from the recently acquired Volante Group. Despite this, Citigroup maintains the acquisition will prove profitable for the group in the future given it was acquired relatively cheaply and the current problems appear isolated in the Product solutions division and so should be addressed over time.
Comparing Citigroup’s update with Thomson One data shows the broker’s EPS forecast for FY06 of 14.5c is below consensus which still stands at 16c. Last year the company reported EPS of 14c.
Citigroup believes upside from the Volante purchase is also possible from potential new business it brings to the group, with the South Australian government IT services contract one example. Volante has been named as a preferred supplier, leading the broker to give Commander an 80% chance of getting a 50% share of this contract. Success here would flow through into other areas, as smaller contracts for additional products and services are likely.
Additionally, the broker sees potential for the group to increase its cross-selling opportunities among Volante’s managed services customer base, which would also create some further scale benefits. While this may prove more difficult, the broker estimates Volante overall offers the potential to add about 10c/share to its valuation.
Further and more substantial valuation upside comes from the ability of the company to successfully deliver on its broadband strategy of converting its small and medium enterprise clients from PSTN/ISDN to DSL connections. Achieving this would boost margins, the broker estimating there could be a positive impact of as much as 70 basis points by 2009 given DSL margins run at almost double those for PSTN/ISDN.
Assuming the company is able to increase its conversion rate from 70 customers per week in FY07 to around 200 per week in FY09, the broker estimates this could add up to 25c/share to its valuation. There remains the potential for the company to add additional upside through acquisitions, as the broker points out the balance sheet appears under-geared currently.
As this potential upside is not factored into the broker’s estimates, it points out its forecasts appear conservative and supports its decision to maintain its share price target of $2.40 despite the earnings downgrades this year and in FY07. Its base valuation is in line with its price target, but would increase to $2.75 if the company is able to deliver on its upside potential in the longer-term.
This compares to an average share price target of $2.35 as per the FN Arena database, which shows the stock is rated as Buy by two brokers and equity researchers, compared to one Underperform rating and four Hold recommendations.
Thomson One data show the stock is relatively positively rated by the nine experts in its database. Thomson’s median price target stands at $2.40.
The last closing price for Commander was $2.05.