Australia | Sep 04 2009
By Chris Shaw
Since it acquired Westnet in May of 2008, internet service provider iiNet ((IIN)) has delivered two good six monthly results, culminating in net profit increasing to $25.6 million in FY09 against the $19.9 million the company earned in FY08.
In the view of RBS Australia, the company looks set to deliver solid growth for at least another 3-5 years before it is likely to experience any impact from the establishment of the National Broadband Network (NBN), so the broker has today initiated coverage on the stock with a Buy rating and a price target of $2.73.
What should support earnings in the next year or so, in the broker’s view, is the ongoing on-net migration of Westnet customers, as on its estimates there are 35,000-40,000 such migrations due to occur in the coming year. As well, FY10 will see the company enjoy a full year of earnings from the migrations completed in FY09, which the broker expects will support an increase in margins.
This upward trend in margins should continue through to FY12 on the broker’s numbers, with a peak of just over 19% achievable in its view. As the NBN gains traction RBS expects margins will decline to something in the order of 15% as the company becomes more of a service provider.
The scale benefits of moving customers on-net is one element to the company’s growth outlook, but the broker also expects further acquisitions, especially before the NBN is established and such a strategy becomes tougher to implement.
The other issue with the NBN is it may require the company to invest more in capex to reposition itself, but the broker is forecasting an increase in free cash flow in the next couple of years and in its view this should leave the group well placed to do so if required.
In terms of earnings forecasts, the broker is forecasting earnings per share (EPS) outcomes of 21.8c in FY10 and 25.6c in FY11, which compares to the 16.6c generated in FY09. This puts RBS slightly ahead of market consensus according to the FNArena database, which currently stands at 21.1c in FY10 and 25.2c in FY11.
Given its earnings estimates the broker has a discounted cash flow based valuation on the stock of $2.73, which is where it set its price target. This implies a P/E (price to earnings ratio) of 12.5x FY10 earnings. Its target is at the upper end of the range among brokers covering the stock as only JP Morgan is higher at $2.77, while Macquarie has a target of just $2.05.
Both brokers rate the stock as a Buy, JP Morgan on valuation grounds and to reflect its view the profit result for FY09 was a solid one thanks to better than expected outcomes for both costs and revenues. JP Morgan sees this as setting up the company nicely to deliver another solid result in the coming year.
Macquarie was a little less optimistic with its profit result commentary when it reviewed the stock last month, suggesting while the FY10 outlook was good, the questionmarks are increasing with respect to earnings in later years given increasing competition in broadband in particular. Given this, the broker wants to further review its outlook but at present it retains its positive view.
Overall the FNArena database shows the company is rated as a Buy by the four brokers to cover the stock, with an average price target of $2.51. Shares in iiNet today are slightly higher and as at 11.15am the stock was up 3c at $2.17, which compares to a range over the past year of $1.00 to $2.31.
On current consensus forecasts, the shares offer a dividend yield of 4.6 in FY10 and of 5.5% in FY11.
