Big Growth Numbers Projected For iiNet

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By Chris Shaw

Internet service provider iiNet ((IIN)) is highly recommended on the Australian market, the FNArena database showing four Buy ratings and one Hold recommendation among the five major stockbrokers covering the company.

The positives views reflect a positive earnings outlook, with Morgan Stanley noting consensus expectations for earnings per share (EPS) growth for FY10-FY12 stand at a little more than 20% annually. Consensus EPS forecasts according to the database stand at 19.9c this year and 26.6c in FY11.

Morgan Stanley's forecasts for FY10 and FY11 are broadly in line with this at 18c and 26c respectively, but the broker takes the view EPS growth through FY13 is likely to be higher than the market expects at around 25%.

Acquisitions should assist in this regard, while Morgan Stanley also expects customer migration to the iiNetwork will boost group margins and profitability during this period. This outlook sees the broker initiate coverage on iiNet with an Overweight rating within an In-Line industry view.

Given its earnings growth expectations, Morgan Stanley suggests iiNet is cheap at current levels, as its forecasts imply earnings multiples of 11.3 times in FY11 and 8.8 times in FY12. This stacks up well against peers, as competitor TPG ((TPM)) is estimated to be trading on respective multiples of 15.8 times and 11.4 times in comparison.

Looking at iiNet broadly, Morgan Stanley sees a key attraction as the ability to add subscribers and margin simultaneously by moving new subscribers onto its largely fixed cost network. This is partly being achieved by acquisitions as the sector continues to consolidate, the March purchase of Netspace being the most recent example of this strategy.

The National Broadband Network offers some risks to iiNet in Morgan Stanley's view, largely as the company's core business relies on efficient access to assets it doesn't own such as the NBN in the future and Telstra's ((TLS)) last-mile copper network now.

But in Morgan Stanley's view iiNet is well placed to operate under the new structure as scale will be of greater importance, as will factors such as service, quality, brand and content. Each of these are relative strengths for iiNet in the broker's view.

Content is a good example, as the company has been conducting trials of internet TV service FetchTV. Earlier, JP Morgan noted while there wouldn't be any great financial benefit from re-selling the service, it would be another attraction for subscribers and so help reduce customer churn.

Management has set a medium-term target of 15% DSL broadband market share and Morgan Stanley suggests risk is to the upside in this regard given current market share stands at 12.4%.

The NBN should have some longer-term impact on margins for iiNet, especially if Telstra begins to compete more aggressively to reverse market share. But as the company can boost margins through migrating customers onto its network, Morgan Stanley expects iiNet should be able to withstand this increase in margin pressures.

Compared to a current share price of around $2.90, Morgan Stanley has a base case valuation on the stock of $3.76, so it has set its price target near this at $3.80. A bull case scenario where iiNet achieves market share of around 20% in fixed broadband implies a valuation of $5.54, while a bear case of a halving in margins and no further market share gains implies a valuation of $1.24.

Morgan Stanley's $3.80 price target compares to an average price target according to the FNArena database of $3.02, which reflects the stockbroker's above consensus earnings growth expectations.

Shares in iiNet today are slightly higher and as at 10.55am the stock was up 3c at $2.95. This compares to a range over the past year of $1.61 to $3.00 and implies around 3% upside to the average price target according to the database.

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