Morningstar analysts have identified (ASX:TPG) telecom as the most undervalued telecom stocks in the ASX 200 detailing multiple catalysts for earnings recovery and growth.

In a new special report, Morningstar equity analyst Brian Han says the newly merged broadband and mobile retailer has suffered a series of brutal earnings headwinds in recent years including the loss of its key high-margin customer base during the pandemic and a hit from subscribers moving across to the national broadband network.

However, he sees “clear catalysts for earnings recovery” on several fronts, and forecasts group EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) rising to $2.2 billion by 2024, up $1.7 billion in 2021, equating to a compound annual growth rate of 8%.

“Investor concerns linger over NBN's damage on fixed-line broadband, timing of recovery from the pandemic, and the recent exodus of TPG executives following the Vodafone merger,” he says.

“The turnaround potential is not reflected in the current undemanding 7.2 times 2022 forecast EBITDA.”

Han sees several avenues for TPG’s earnings to recover in the near term.

First, he sees a reduction in the so-called ‘NBN impact’ which has plagued TPG's earnings for years. The introduction of the national broadband network (NBN) saw many of its subscribers switch from the higher-margin private broadband network to the lower-margin government fixed-line access infrastructure, resold via TPG. “The good news, however, is that TPG now has just $27 million of EBITDA left to lose, or 52,000 ADSL subscribers,” Han says.

Additionally, Han believes that TPG will be able to bring in revenue by winning subscribers back from NBN. With NBN providing unreliable services due to coverage issues and extensive infrastructure required for delivery, TPG can offer Australian customers reliable fixed wireless services.

Morningstar estimates that for every 100,000 NBN subscribers TPG signs to their fixed wireless listings, EBITDA could increase by $18 million to $34 million per year. Han is forecasting that TPG will gain another 200,000 fixed wireless subscribers over the next three years across 4G and 5G equating to $52 million in EBITDA.

Huge Damage from NBN but Only 115,000 ADSL Subscribers (< AUD 30 million EBITDA) Left to Lose
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Source: Company reports and Morningstar estimates

Second, Han anticipates imminent recovery from Covid-19 earnings damage. The pandemic had a deeper impact on TPG than on other telcos due to its core customer base, made up of travellers, immigrants and students and the loss of high-margin roaming revenue. He forecasts “substantial recovery of earnings” over the next three years, with 85% of EBITDA loss to be recouped, adding that TPG's leverage to the recovery should be greater than its competitors.

“As border restrictions ease and migration plus travel activities normalise toward pre-pandemic levels, the relative benefits to TPG are likely to be material,” he says.

COVID-19 Decimates High-Margin Roaming and Other Businesses but Inflexion Point Reached

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Source: Company reports and Morningstar estimates

Finally, Han says the unprecedented intensity of the competition among the three major telco players is “rationalising”. Telco companies entered a “discounting spiral” in recent years meaning prices of multiple products from mobile to internet broadband and enterprise telecom services were all being heavily discounted.

Han says that with an increase in capital investment for Telstra, Optus and Vodafone, the three mobile operators are incentivised to generate a decent return which will help to normalise the discounting spiral. He forecasts that this movement away from telcos aggressive discounting products and shifting the focus to profitability will lead to an increase in EBITDA of $160 million for TPG.

The special report follows a difficult period for TPG, booking a 13% fall in EBITDA over 2020 and 2021.

TPG has struggled with structural changes in the Australian telecommunications industry. The rollout of the NBN forced TPG to become a reseller and severely impacted its consumer broadband margins.

In addition, Covid-19 impacted TPG’s earnings with a reduction in mobile needs from a key customer base - travellers, students and Migrants.

This all occurred over the backdrop of a competitive telecommunication market, with prices slashed so low that remaining profitable became a challenge.

Shares in TPG are trading at a 21% discount to Morningstar’s fair value of $7.40, closing on Friday at $6.10.

Additional drivers of growth: Merger, infrastructure assets

Beyond industry and economic dynamics, Han sees additional drivers of growth within TPGs business.

While the company’s merger with Vodafone in 2020 has delivered some synergies, Han expects more will be coming.

“The merger has not yet generated the full benefits, but the strategic merits lie in the fact that TPG/Vodafone have complementary businesses,” he says.

Han describes the complimentary business as TPG’s advantage in the fixed-line broadband market and Vodafone’s ability to dominate the mobile market. He believes that together “the combined entity can attack the corporate market more aggressively".

Han forecasts EBITDA from the corporate telecom unit to increase to over $580m by 2026, up from the $492m delivered in 2021.

Moreover, the TPG and Vodafone merger has allowed a reduction in costs. By combining the two companies they can save on duplicate costs. Morningstar is projecting that by the end of 2022, TPG will save 145 million dollars from the synergies of the merger.

Han also sees potential upside for sales from infrastructure assets. He estimates TPG’s 1200 passive mobile sites have a collective worth of at least $1 billion. There is an opportunity for TPG to cash in on their infrastructure assets as Telstra did in late 2021 after selling a 49% interest in its mobile towers.