TIME TO BUY TELCOS?

SXKP is the second worst performing sector -5% YTD, and -12% relative to the ESTX. Since the start of 2016 its almost 30% underperformance, and that during a period of yield compression that has benefitted other yielding sectors.

Why have the telcos been so poor? Competition is intense so growth is hard to come by, leverage is high and dividends are not all secure. In a very forgiving market, the sector continues to be punished.

Is that about to change? Competition will continue, but there is evidence of more rational pricing in many markets. Consolidation themes do not go away either, already in the Netherlands, Denmark and likely France noises again given Altice’s recent problems. Leverage will continue to be an issue for most of the sector, and the high yield move throws that into sharp relief. But should that settle we think the sector deserves to re-rate from here.

VOD has provided incumbents with a blueprint for cutting costs sustainably through digitalisation. Not all will be retained, but what isn’t will be used to cement competitive positions vs challengers who do not have the same fixed cost base. VOD is now printing 2% topline and 10% EBITDA growth. It is throwing off cash so the div is covered at 6% and trades on 6.5x EBITDA. NESN and ULVR have undergone similar exercises, are also increasingly hurting from structural competitive challenges and trade with 3% yields and on 14/15x EBITDA. Seem fair?

ORA have talked at the weekend about having 10k staff in stores across France, TEF and KPN are already embracing digitalisation and the theme will grow. Vs a market where a lot has played out and the market is getting worried about valuation, any bit of good news in a sector that has perennially underperformed should be embraced.

Also technically the picture might be turning they used to trade with each other but has been a material divergence over the last 18 months. See Chart below

BUY A BASKET OF INCUMBANTS: VOD/TEF/ORA/KPN/DT