Fibre Binds A Strong Outlook To Amcom

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-Strong gross margins to continue
-Slight IT weakness offset by cloud
-Costs of generating revenue fall
 

By Eva Brocklehurst

Fibre is the thread that binds a positive outlook to Amcom Telecommunications ((AMM)). The company delivered on expectations once again in FY13, meeting guidance of around 20% growth in underlying earnings. The result was driven by leveraging the in-ground fibre network, a valuable asset which the company owns.

The fibre sales run rate continues at $1.8 million per month despite softness in the Western Australian resources market, the prime geographic region for Amcom. The fibre business operates at high gross margins of 84% and because of the relatively flat cost structure the increase in revenue via new customers and additional products flows nicely to the bottom line. A softer resources sector is impacting new sales in Western Australia but other sectors are offsetting this. Strong contract wins in Northern Territory with corporate and government customers were highlighted by Macquarie. Fibre revenue was up 11% in FY13 and third party networks sale accounted for 20-30% of new sales, although they attract a lower margin at 30%.

IT services and hosted/cloud services is a newer area of the company's business that leverages off the fibre infrastructure. Macquarie notes the sales cycle is slower, as the deals are larger and revenue growth has been affected by several low-margin contract cancellations in the first half. Credit Suisse also found IT weakness caused operational revenue to miss forecasts by 3.5%. There was also a $1m miss on data networks. Not large in the scheme of things and earnings of $40m were in line with the broker, as stronger cloud, hosting and Amnet margins offset the IT weakness.

Macquarie notes the second half was tough for L7 Solutions business and revenue and earnings fell significantly versus the first half. This reflects aggressive competitor prices and weaker resources sector demand. Amcom has moved to reallocate billable resources to other parts of the business such as the cloud. Hosted and cloud services are a growing focus for the company, contributing $5.7m for the year against $3.3m previously. Macquarie observes Amcom currently has around $6m of recurring billing from the cloud as it works to leverage L7 relationships.

Fibre is likely to stay the key driver of revenue and seems to have several more years of development ahead, according to CIMB. The high margin is expected to continue to creep up as utilisation rates are increased. Hosted and cloud services make a useful and growing earnings contribution, in the broker's opinion. Previously, CIMB considered capex may flatten and remain below $20m over a three-year forecast period. Now, it's expected to increase as Amcom steadily builds out its infrastructure. The company has a strong and focused management and a consistent track record of delivering solid and reliable results and CIMB sees no reason why this won't continue for several more years.

Amcom acquired a small Perth data centre in July which provides some capacity to underpin cloud and hosting growth in the short term. Credit Suisse expects another purchase of a larger facility in FY14. The broker continue to be highly attracted to the business case on a two and three-year view. As the stock is now trading on 20.8 times FY14 estimated price/earnings there is limited room for upside earnings surprise in FY14. Hence, Credit Suisse is content to maintain a Neutral rating for now. CIMB is mindful of the same things and retains a Neutral rating. The upside risks include better-than-expected subscriber growth while downside risks include greater capex or margin erosion, if growth relies too much on low-margin IT services.

Key to several broker views is the fact that Amcom's telco business is 90% fibre and, with a more established network, Amcom can leverage each dollar of data revenue with lower incremental capital spending. This impresses Citi. The broker noted the costs of generating incremental revenue on the network have fallen 10%. Moreover, sales will be supplemented by the Cisco Unified Communications offering, expected to come on board in the fourth quarter of FY14. Macquarie expects this new Cisco partnership will involve further costs in sales and marketing ahead of revenue opportunities, hence there will be a minimal contribution in FY14. Nevertheless, the opportunity looks promising given the ability to leverage off Cisco's strong enterprise market share.

On the FNArena database there are two Buy and two Hold recommendations. The $2.12 consensus price target shows 3.8% upside to the last share price and the price target has moved from $1.96 ahead of the results.
 

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