Australia | Aug 26 2014
-Energy connections grow strongly
-Commander turning around
-Main uncertainty in NBN
By Eva Brocklehurst
M2 Telecommunications ((MTU)) has reached the $1bn revenue mark for the first time. FY14 guidance was easily met. Indeed, it was provided 12 months earlier when Dodo/Eftel had only contributed two months of profit. Such confidence is meaningful for brokers given a considerable amount of FY14 and future earnings growth is being generated by Dodo.
This underscores a Buy rating for Citi. Earnings margins remained comparable with the prior year at 15.6% while services grew and costs were reduced. The company is now focused on operational improvements and integrating its acquisitions as well as accelerating the roll-out of the Dodo kiosks beyond the current 20. Following three notable transactions, Primus, Dodo & Eftel, Citi believes FY14 was the year of consolidation and FY15 should be the year of organic growth. The company is differentiating its offering from a sales organisation in the telco space and this diversification remains paramount to the investment thesis.
Energy connections grew 66% in the year and are proving to be a core product for the Dodo Connect kiosks, offering customers a lower price point. Kiosks are a low-cost alternative which target high-traffic regions and do not need the capital outlay associated with store fit-out. Macquarie observes energy connections were also a key driver and are proving to be a core product in the kiosks. Another aspect is the company has traditionally low capex commitments, given it has minimal ownership of the network infrastructure. The company has guided that capex will be 2.5% of revenue in FY15. Borrowings remain manageable with a debt to earnings ratio of 1.6 times expected in FY15. Macquarie is also encouraged by the initial response from Dodo's NBN product. This is still relatively small but management notes a high take up from existing customers.
Credit Suisse considers M2 Telecom is a mispriced emerging organic growth story. Acquisitions clouded the page last year and first half cash flow was weak. Nevertheless, the broker has witnessed Dodo driving a significant transformation in cost discipline and customer acquisition approach. The broker expects growth of 15% per annum. Moreover, if M2 can maintain, or accelerate, subscriber growth this could mean further upside to Credit Suisse's forecasts. The broker retains an Outperform rating.
For Morgan Stanley there is also a potential turnaround story in the Commander business. The broker was concerned that this segment would not be able to generate organic growth because of uncompetitive prices and a weak product mix but the company has addressed these issues by reducing prices and introducing a hosted voice phone product. Consequently, Morgan Stanley has upgraded FY15-18 earnings forecasts by 3-16%. The broker has an Equal Weight rating, believing the appropriate discount to peers is reflected in the current stock price. Morgan Stanley prefers iiNet ((IIN)) and TPG Telecom ((TPM)), with Overweight ratings on both.
CIMB also accepts the company has demonstrated, via its performance and outlook, that it justifies a higher market valuation. Hence, an upgrade to Hold from Reduce. CIMB expects acquisitions to be an ongoing theme but other catalysts are likely to have significant implications in coming weeks. Given the company's relative size, it becomes more difficult for acquisitions to add meaningfully to value. This is likely to swing the focus back to investment in long-term infrastructure. Much of the company's potential derives from the impact of the current regulated access model on network investment and the economic outlook for the NBN. Given the mismatch of risk and return in the sector between services and infrastructure telcos, it seems likely that the regulatory changes will tend to favour network investments over services, in CIMB's view. This all adds to the uncertainty regarding actual outcomes.
On FNArena's database there are two Buy and two Hold ratings. The consensus price target is $7.45, suggesting 4.1% upside to the last share price. The dividend yield is 4.1% and 4.7% on FY15 and FY16 forecasts respectively.
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