Buy, Hold, Sell: Telstra tipped to retain long-term dominance despite dip in sentiment
Telstra may be facing fierce competition and low investor sentiment but it has built-in advantages to ensure long-term dominance, while software play Xero appears overvalued amid higher cash flows, say Morningstar analysts.
Buy (★★★★★): Telstra Corporation Limited (ASX: TLS)
Telstra is the dominant player in the Australian telecom industry, but it’s no secret the company is hurting. Its mobile business continues to suffer from intense competition, which will get even worse when TPG Telecom comes into the market.
Telstra is also spending big to upgrade and extend its mobile network advantage over its peers, and the National Broadband Network is continuing to wreaking havoc with margins.
As a result, investor sentiment towards Telstra is at record lows, with many left worrying about the stock price and the company’s future. However, Morningstar equities analyst Brian Han says these concerns are exaggerated.
“At Morningstar, we look longer-term out, as we always do, and longer-term out, we do see Telstra maintaining its dominant market position in the telecom industry,” Han says.
“It is investing to maintain its network advantage and we do believe longer-term there is potential for 5G to bypass the unsustainable economics of NBN and make it more profitable for Telstra to gain subscribers and customers.
“We see [investor concerns] as excessive and overlooking the longer-term benefits from Telstra’s aggressive current response to completion, its network advantage and the upside from eliminating $1.5 billion in underlying core fixed costs by the end of fiscal 2019.”
Morningstar’s fair value estimate on narrow-moat rated Telstra was cut in mid-May by 4 per cent to $4.40 per share following the weak trading update. The current share price ($2.77) is at a 37 per cent discount to that estimate, making Telstra a five-star stock.
WATCH: Morningstar analyst's view on Telstra (16/05/18)
Hold (★★★): Australia & New Zealand Banking Group Ltd (ASX: ANZ)
ANZ Bank has slipped behind its major bank peers as a result of its lower return Asian businesses. The strategy, designed to leverage fast-growing trade and investment flows within Asia and among Asia, Australia and New Zealand in the aftermath of the global financial crisis, failed to deliver higher growth.
“The super-regional concept has caught up with reality,” Morningstar equities analyst David Ellis says.
However, ANZ is now backtracking with a divestment spree -- disposing of non-core assets, simplyinging the group structure -- and renewing its local focus, where household and business credit growth provides upside.
Most recently, the bank divested its struggling NZ life insurance business OnePath to US-based global health service giant Cigna Corporation for NZD$700 million ($644 million). The sale generated about NZD$50 million, “a positive for ANZ Bank considering the increasing profitability challenges OnePath Life NZ has been facing in recent years,” Ellis says.
ANZ also recently finalised the sale of five retail and wealth businesses in Indonesia, China, Hong Kong, Taiwan and Singapore to Singapore's DBS Bank, and the sale of its Vietnamese retail business to South Korea-based Shinhan Bank.
“CEO Shayne Elliott wasted no time in overhauling senior management and implementing changes in strategy,” Ellis says. “The renewed focus on retail, commercial and institutional banking in Australia and New Zealand is expected to improve earnings, with decreased emphasis on the previous super regional Asia strategy.”
However, other concerns loom. They include slower earnings growth, increased loan-loss provisioning, higher restructuring charges, pressure on capital levels, and potential for lower dividends.
For these reasons, Morningstar analysts believe the ANZ share price ($26.64) is trading close to its fair value estimate of $30.00.
Sell (★): Xero Limited (ASX: XRO)
Xero's subscriber growth is an incredible success story. The number of subscribers has grown from just 950 in New Zealand in 2008 to 1.4 million globally in fiscal 2018. In fact, the 351,000 subscribers Xero added in fiscal 2018 is greater than MYOB's entire cloud subscriber base, making the company largest provider of accounting software as a service, or SaaS, to the small and medium enterprise, or SME, market in Australia and New Zealand.
The company’s quick expansion into Britain appears to be strengthening, with Xero now the market leader and UK-based Sage Group appearing to struggle in the small and medium enterprise segment.
“We have increased our growth forecasts for Xero's UK business and now assume the company achieves a market share of 21 per cent, or 1.2 million subscribers, within the decade, up from 17 per cent previously,” Morningstar equities analyst Gareth James says. “We expect the UK government's Making Tax Digital project to act as a major catalyst.”
However, at the current market price of $40.54, the shares are materially overvalued, in Morningstar’s view as cash outflow was greater than expected. “Although the reported net loss after tax of NZD$28 million was better than Morningstar's forecast loss of NZD$39 million, the reported free cash outflow (operating less investing cash flow) of NZD$37 million was worse than analysts NZD$24 million forecast,” James says.
Another concern is Xero's expansion to the US, where the company is going up against major rival Intuit. There is also a risk that Intuit could outspend Xero and aggressively bring a global model to the Australian market.
Morningstar increased its fair value estimate for Xero by 9 per cent in mid-May to $24 a share.
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Emma Rapaport is a reporter with Morningstar, based in Sydney.
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