TPG: An attractive yield play

With lots of hype around some rapidly growing sectors with fast paced businesses, it can be easy to overlook opportunities amongst the noise.

In this weekly update, Senior Analyst Gaston Amoros and I take a look at the telco sector, a sector that was sprawled across the headlines of major newspapers a decade ago. But fast forward to now, the sector has matured and large-scale companies are making it hard for new entrants to make a dent.

In today’s video, we take a look at one of the telco stocks in the Australian Shares Fund, TPG (ASX: TPG). We share our insights around why, in the current low-interest rate environment, TPG’s yield may be seen as attractive and why there may be more in terms of return and upside as well.

While the telco sector has settled down and there are fewer competitors coming along, with wireless broadband on the radar, find out why there could be an opportunity for certain telcos when it comes to acquiring customers in high-density areas.

Edited transcript:

Steve Johnson: Hi everyone and welcome. It's Steve Johnson, Chief Investment Officer at Forager Finance. And today we're talking Telcos with Gaston Amoros, Senior Analyst on our Australian fund. Hi Gaston.

Gaston Amoros: Hi Steve.

Steve Johnson: Now for your sins, you've been covering the Telco Sector here in Australia for quite some time, it's gone from a growthy, sexy sector back in the 2000s to something that is quite boring now and you don't see a lot of it on the front pages of the paper. What's the general backdrop here and why has it become so boring?

Gaston Amoros: Well, the sector has consolidated quite a lot in the last decade or so. We were basically left with three large guys, Telstra, TPG, and Optus, given the workers just got taken private. We have a few smaller players like Unity Wireless, also broadband and MNF, but it's highly, highly consolidated. It's a mature sector, there isn't much growth or innovation that you can monetize. It is hard to disrupt even the big network effects, but that's generally high cashflow that companies typically pay out as needed. And so, yes. As you said, it is perceived as mature, boring, but stable, we've been paying sector that people typically own for income.

Steve Johnson: Now we don't own Telstra, but I know a lot of people out there do. Maybe just give your 30-second thought on Telstra as an investment at the moment.

Gaston Amoros: I think it was very interesting 12 months ago where the shares were at $3. Since then two things happened, the company reassured investors that they dividend of 16 cents is safe. And then the company moved to highlight the value of its infrastructure, be it through a potential spin out of the Infraco or by selling 50% of its total assets, at a very good price. Then everyone got excited and sold the shares at 40% higher. You still get a decent yield of 4%, but it's not the good opportunity that it was 12 months ago.

Steve Johnson: Yeah, I think in this interest rate environment, a 4% yield is certainly not crazy with a lot of other asset prices out there. It's not the one that we own in the portfolio, but we do own TPG. Now, this was a really popular founder-led business. David Teoh built this up and created a huge amount of shareholder value. He's merged it now with Vodafone and as he heads for the exit it seems to be a much less exciting story. What is the investment case here?

Gaston Amoros: It's very simple. It is cheap. We're talking about 8% free cash flow yield, which is definitely cheap. They have two businesses mobile and fixed. The mobile business is getting better, the prices are drifting higher and that clearly helps margins given the high fixed cost nature of the business. On the fixed side, margins have been compressed by going from reselling ADSL to selling NBN and from here on whether the NBN cuts prices or the networks themselves bypass the NBN and by selling 5G wireless, either way, they win by making a greater margin as a reseller. And finally, debt is coming down and as it comes down, they'll start to pay a dividend in line with that free cash flow generation. So in a nutshell, that is the case. The fact that David Teoh stepped down as chairman is not good for sentiment but it doesn't affect the way the business is run.

Steve Johnson: Yeah, not anymore. I think this is a business now that needs to focus on cash generation and paying it out. And we do view it as much more of an infrastructure type stock and that 8% yield being particularly attractive in the current environment. There is one little piece of optionality here. I've just moved houses recently, and we are not connected to the NBN in our new house. We've signed up with Telstra's mobile 5G plans, a little box in our house that's a mobile connection to the internet, but on the 5G network, the speeds have been amazing. We haven't had any trouble with the connections at all. It's actually been a fantastic home internet service and this opportunity for the existing mobile players to cherry-pick NBN customers seems like something that could be interesting to me.

Gaston Amoros: Correct Steve. The likes of Optus and TPG are cherry-picking high-density customers with their 5G offering. The way it works is you roll out a bit of infrastructure and you get a customer at the same price at which you were reselling the NBN, but it's on your own network, so you don't have to pay away 80% of that to the NBN. It's all profit for you. So it's very attractive. Although to be clear, we're not arguing for investment in TPG purely because of that. But it is a small upgrade to their earnings expectations and another driver of our thesis here.

Steve Johnson: Yeah. And the big customer acquisition expenses there have already been spent in terms of acquiring those customers. So hopefully some modest cross-sell could add to the cash flow, but it's the core cash flow from their existing infrastructure that we're most interested in here. I think there's a really good case in a portfolio in today's market for some of these larger, boring, stable businesses that are going to pay your cash flows. There's a huge amount of excitement and optimism but I think this part of your portfolio is really important and TPG can be one of a few of these types of businesses for you.

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Founder & Chief Investment Officer

Steve began Forager Funds in 2009, and now manages approximately $470m across two funds. Offering a listed Australian Shares Fund (FOR) and an unlisted International Shares Fund, Steve focuses on long-term investing in undervalued companies.

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