European Telecom Stocks on Sale

With a lockdown still in place – at least in part – here in Canada, digital communication is now the norm. Services like wireless, cable and internet have become ever more essential for businesses and individuals to remain productive and for economic activity to continue uninterrupted. As a result, the telecom sector has remained resilient as evidenced by the 8% gains for the S&P Telecom Select Industry Index so far in 2020, handily besting the measly 0.86% for the S&P 500 for the year to date, as of July 30.

European telecom heavyweights are well positioned to benefit, both from pandemic, and after, as demand for reliable phone and internet services will continue to create a tailwind of growth for these companies while shielding them from any future cataclysmic black swan events. These blue-chip European telecom businesses are nimbly adapting by reducing costs, improving efficiencies and growing their geographic footprint to remain competitive and profitable in the current challenging economic environment and beyond, and the stocks are trading at a significant discount to their fair value estimates.

Leading French carrier, Orange (ORA) generates about 40% of sales from France, while Spain and Poland are the firm's next largest revenue generators. The company's two-fold strategy is built around bolstering its core business (fiber build-out in France), and diversifying through strategic acquisitions into banking, cybersecurity, cloud services, and e-health.

Orange is a “well-positioned European telecom firm at the front of converged services (merging fixed-line telephony, broadband, pay-TV and wireless telephony) and the upcoming 5G deployment,” says a Morningstar equity report, noting that high-quality networks and service bundling “allow for competitive differentiation in the higher-value market segments, where the customer base is more loyal.”

In France, its home turf, the firm has made considerable investments in fiber deployment and enjoys a leadership position with 3.3 million fiber service subscribers. In neighbouring Spain, the wireless operator has almost 80% of its broadband customer base on its fiber offering. Orange generates 10% of its revenue from its exposure to Middle East and Africa, a fast-growing wireless market.

“With operations in 18 African countries, the region presents significant growth opportunities due to current low mobile penetration rates,” says Morningstar equity analyst, Andreea Matysiak. “Orange will continue to generate solid free cash flow while growing its dividend,” says Matysiak, who puts the stock’s fair value at EUR 16.

British telecom behemoth, BT Group (BT.A) provides phone, internet access, and television services to residential and business customers across the U.K. The firm also owns runs a global services business, which remains one of the largest international providers of managed networks and IT services. BT operates four business segments: consumer services, enterprise services, global services and Openreach service.

In a highly competitive U.K. telecom market, “BT remains the largest provider, with roughly 30% wireless market share and 35% internet access market share,” says a Morningstar equity report, noting that a significant market share and a large customer base help provide BT a cost advantage that’s hard for peers to match.

That said, BT's fiber expansion efforts have been hobbled by regulatory hurdles, slowing its network plans. “The firm built fiber-to-the-curb across most of the country several years ago, but its only upgraded about 3 million customer locations (about 10% of the total) to fiber-to-the-premises,” cautions Morningstar sector director, Michael Hodel.

BT Group recently announced plans to build fiber network to 20 million locations, or about 70% of the country, over the next several years. “To support the fiber initiative and provide flexibility during the coronavirus pandemic, BT will suspend its dividend until 2022 and cut the payout by roughly half when it resumes,” says Hodel, who lowered the stock’s fair value from GBP 320 to GBP 250, to reflect higher expected capital spending associated with the firm’s planed fiber network as well as the impact of Covid-19 on its revenue.

British telecom major, Vodafone (VOD) is one of the largest wireless carriers in the world with about 270 million wireless customers served through majority control, joint ventures and partnerships across the globe. More recently, the firm has been boosting its cable operations and fixed-line networks through acquisitions. Europe accounts for 75% of its service revenue, with major operations in Germany (30% of total service revenue), the U.K. (13%), Italy (12%), and Spain (10%). Outside of Europe, the company owns 65% of Vodacom, its African subsidiary, and stakes in operations in India, Australia, and the Netherlands.

Vodafone has reinvigorated its business by adding fixed-line assets in core markets, moving out of unproductive geographies, and tying up with local players in other countries. “Overall, Vodafone holds a solid set of assets, with opportunities to grow cash flow and the potential to unlock additional value for shareholders,” says a Morningstar equity report.

Vodafone’s narrow economic moat is rooted in cost advantages and efficient scale as a leading global phone company, which allow it to source equipment at lower prices. “The firm can develop a product in one country and roll it out to others at minimal additional expense,” points out Hodel, who recently pared the stock’s fair value from US$27 per ADR to US$24, due to weakness in the euro.