Stock analysis: Telecoms

There has been a lot of noise about impending economic uncertainty, and likely stock market volatility so where might some of this roller coaster be avoided? Nice safe defensive stocks maybe? They don’t come much more defensive than utility/energy companies – providers of water, electricity etc. However, these come with increasing regulatory oversight, potentially squeezing profits, and the current Labour party have indicated a desire to nationalise such businesses. Another sector that has very similar defensive characteristics without the same restrictions and risks is telecoms – providers of mobile and internet infrastructure. Today these provide a service considered indispensable by most, so should have a very dependable income, and hopefully a nice safe investment. Lets find out.

There are 2 telecoms businesses listed on the FTSE 100:

·        BT Group (BT.A)

·        Vodafone (VOD)

And 2 listed on the FTSE 250:

·        Talktalk Telecom Group (TALK)

·        Telecom Plus (TEP)

Telecom Plus also provide a range of energy services so at least part of their business may end up subject to similar regulatory and political risks as other utilities/energy providers, and since nearly 80% of their 2018 revenue was generated by their Electricity and Gas segments I’m excluding them. They do, however, have a very interesting low capital business model, so I’ll be taking a closer look at them at some point. (If you're wondering why the link for TEP takes you to utilitywarehouse.co.uk, scroll to the bottom of the webpage and you'll see that it is a subsidiary of TEP.)

There are other telecoms businesses out there of course, I bought a few shares of MANX last month, but to keep this manageable I will start with these bigger businesses.

So, Vodafone, BT, and Talktalk... lets crunch a few numbers and see if any of them merit a closer look.

How big?
Since these 3 live in different indices, or in different parts of the same, let's first check out their respective sizes:

In terms of size (24^th Feb 2019): 

	Market Capitalisation	revenue	employees	% rev per employee
BT Group	£22629m	£23723m	105800	0.0009%
Talktalk	£1123m	£1708m	2226	0.0449%
Vodafone	£37889m	£41214m (€46571m)	104000	0.001%

For all financials I’ve taken the last 10yrs published accounts, from 2009 to 2018. It would be no fun if all 3 companies reported in sterling, so Vodafone report in Euros, so I’ve translated everything back into sterling using historical average exchange rates taken from here

Vodafone is clearly the largest company here, in terms of market cap or revenue. Both Vodafone and BT Group dwarf Talktalk in most cash and valuation measures, not to mention geographic coverage, however, Talktalk generates significantly more revenue per employee. Does this mean we have a hare and a couple of tortoises here? What would an historic investment in any of these companies have returned?

Don't look back in anger...

£1000 invested in these businesses 10yrs ago would have generated the following return (including dividends):

BT, Talktalk, Vodafone Historical Investment

Well that's not overly inspiring. An investment in Talktalk would have peaked in 2015, and BT around 2016, dropping ever since. Vodafone was plugging away until last year, when it too decided to roll over. The best of the bunch is BT, which would have made a healthy 275% if you'd sold at the top (including dividend payouts). 

	Capital	Total dividends	Total return
BT Group	1713	768	2481
Talktalk	920	851	1771
Vodafone	1097	760	1857

Even less inspiring when you look at the figures rather than the chart. Ignoring dividends, Vodafone would have made me £97 and Talktalk would have lost me £80. From a 10yr investment.

Careless talk

Talktalk have been in bother in for failing to look after data properly in the past, and it doesn't take long to find some disconcerting numbers with their performance over the years too:

Talktalk revenue, profit, fcf

Revenues and profits dipping, and not much cash flow. These are expensive businesses to run, with plenty of money needed for maintaining existing infrastructure, plus moving with the times and investing in new technology - rolling out 5G for example. I was expecting to find pedestrian growth, but I'm struggling to see any growth. Since the share price is flat, dividends must be a key component of the investment case here, but without enough free cash flow, they won't be secure either.

Good times ahead?
Maybe these have been some lean years for Talktalk (admittedly that's a lot of lean years). let's give them the benefit of the doubt, maybe it's all about to turn itself around. So let's take a quick look at Return on Capital Employed (ROCE), one of the preferred measures of how effective the business is at making money:

BT, Talktalk, Vodafone ROCE

Whilst Vodafone might be starting to turn around, BT and Talktalk have been steadily getting less effective. At this point I need a reason to keep looking at Talktalk - as I mentioned above dividends seem to be the only reason to invest, how secure are they?

BT, Talktalk, Vodafone FCF/Dividend cover

Cover for the the dividend at Talktalk has been slim to none for a while. So, this is a business struggling to increase revenues and profits, an investment that after 10ys would have seen my capital decrease, and it has an insecure dividend. Sorry TALK, I wish you well, but you're off the list.

BT isn't doing much better either - at least from what we can see in the above ROCE and dividend cover. Steadily worsening ROCE, dividend cover heading the wrong way...But an investment here 10 years ago, if dividends are included, would have increased by nearly 150%, I wonder what are the chances of this repeating over the next 10 years.

Borrowed time?
BT are not comparing favourably on efficiency (ROCE) or dividend security (FCF dividend cover). Do they at least have a well managed balance sheet?

BT, Vodafone debt vs. income

Above is a ratio of the total debt (long term + short term borrowings) on the balance sheet, which I've divided by operating income. BT has been holding this ratio steady, Vodafone - not so much. A tick in the box for BT? Not if you include pension deficits as debt - and we should. Maynard Paton has an excellent pensions article on his blog. He even uses BT as an example of how a pension scheme might be a hidden timebomb. As can be seen from their annual report BT have a £6bn defined benefit pension deficit on the balance sheet:

BT balance sheet pension deficit

Which grows to an unwieldy £11bn after all liabilities are calculated, which the pension trustees want paid back over the next 13 years:

BT pension repayment

None of which reassures me that BT has been managing it's debt obligations successfully. With £14bn debt on the balance sheet plus another £11bn owed to the pension fund, compared to earnings before interest and tax (EBIT) of around £4bn over the last few years, that's starting to look rather dubious, so unfortunately BT, you're also off the list of potentials.

And then there was 1
I was hoping Telecoms would provide me with a few options of nice safe, steady income stocks. Two of the three business above I certainly wouldn't view as a "safe" investment. So is Vodafone any better? The share price dropped around 30% in 2018, pushing the dividend yield up to over 9% at the time of writing, which I have to admit is tempting. Since the share price has dropped, is it a bargain? Or cheap for a reason?

Vodafone revenue, profit and fcf

Revenue, profits and cash flow have all flatlined over the last decade. Arguably FCF only increasing as a result of cost cutting. There has been a degree of commentary about the dividend, and at the last Vodafone trading update was even highlighted as being sustainable. Which it is. At the moment. Just. They have been generating around £5.2bn of fcf, with around £1.2bn expected to be spent on 5G spectrum bids over the next year, leaving £4bn for the dividend. Suspiciously neat. And it just doesn't leave a lot of wriggle room should anything unexpected turn up. And given Vodafone's fondness for borrowing, even something as bland as increased interest rates may cause a headache, particularly considering £43bn on the balance sheet compared to £4.3bn EBIT.

So unfortunately, it doesn't look like Vodafone will pass muster either - at least as an investment. I think there is a case to be made for taking a punt on it. If the board can do a little fancy footwork with the finances, cut costs, monetise their towers, spend a little less on 5G, the 9% dividend may turn out to be a bargain. 

Vodafone share price

It appears to be moving in a neat downwards channel, and may well be heading upwards and out of the channel. So the risk/reward may be worth a punt. I'm undecided.