This major telecommunications company, a favourite of Australian investors large and small, is trading at a 30 per cent discount to Morningstar's fair value estimate.

Heading up Australia's representation in a sector we rank among the most undervalued Telstra is part of a global communications landscape that is around 14 per cent undervalued, according to a recent Morningstar report.

The roll-out of the National Broadband Network (NBN) has posed a considerable threat to all Australian telco businesses. Further weakening already slim margins on retail broadband providers, it also bolsters existing and new competitors, a huge problem for incumbent leader Telstra.

Telstra chief executive Andy Penn at the end of 2017 flagged increased competition in the mobile market, with TPG Telecom (ASX: TPM) the fourth major operator. "One of our critical objectives is to achieve growth in mobile services revenue which has been under pressure from these competitive dynamics over the last two years," Mr Penn told AAP in November.

"We did see some modest signs of growth in the second half of [2016], however we have yet to see this translate into further momentum."

Morningstar contributor Nicki Bourlioufas last month noted the telco had "plummeted to their lowest level since November 2011, and many investors are now facing a considerable loss on their shares".

While shares have recovered slightly since that $3.10 nadir, they are still only trading at $3.24 as of publication date.

With the well-documented "earnings hole" from NBN, the pressure is on Australian companies in the space to increase productivity. Morningstar equity analyst, Brian Han, notes the need for cost-outs is a global theme, with increasing 4G penetration and a looming jump to 5G and the convergence trend of operators packaging mobile, broadband and pay tv.

"We concede that all telecom operators globally are preaching the need to cut costs. However, Telstra is one of the most leveraged on the upside due to significant inefficiencies buried within its Byzantine mess of legacy systems and processes," Han writes in a report released this week.

However, he is unwavering in his belief that Telstra's narrow economic moat remains intact, "sourced primarily from the cost advantages the group enjoys from its dominant scale and market shares".

Han thinks it unlikely a new entrant could replicate "even a small part of Telstra's extensive infrastructure footprint, scale, and brand power and still earn a suitable long-term return on capital".

Plenty of fat to trim

According to Han, this is reflected in Telstra's labour cost/sales ratio of 19.8 per cent, versus a global average of 14.9 per cent, equating to $1.3 billion upside just from cutting staff expenses to the peer average.

He believes more than half the earnings gap NBN inflicts on Telstra can be filled with productivity gains and cost reductions.

A $1.5 billion cost reduction program is almost half-completed, and Han also notes Telstra has prior form in successfully cutting costs.

"Granted, these past productivity gains may well have been low-hanging fruit, and sceptics may argue that future benefits could be harder to extract," Han says.

"However, we firmly believe Telstra is still fundamentally a large, bureaucratic organisation ripe for further material efficiency and productivity improvements, driven by utilisation of digital technology, data analytics, and customer self-service tools."

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Glenn Freeman is senior editor of Morningstar Australia.

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