This time last year, we published several articles on Livewire (including this one) outlining some of our thinking on Telstra (TLS), and in particular highlighting an investment thesis founded on three sources of potential upside - potential upside that we thought the market may not have priced into Telstra shares. With the Telstra share price up 40% since (plus 19c in fully franked dividends) publication, Livewire got in touch and asked us to review our thesis, provide an update, and outline another unloved company offering good value today.
Since that time, Telstra shares have delivered good returns, and it is tempting to give ourselves a pat on the back for having bought in close to the low point and enjoyed the subsequent gains. The only question to be addressed now is how much further have Telstra shares got to run?
Or is it?
While it is always tempting to judge the veracity of an investment call by reference to the subsequent share price, this can be misleading. Share prices can be driven by factors unrelated to the original investment thesis and it is always good practice to examine the specifics of the original thesis in light of subsequent events.
To recap, the three sources of potential upside that we pointed to last year were:
- Scope for greater-than-anticipated cost reductions
- An improvement over time in NBN economics, possibly through reduced wholesale charges or through fixed wireless substitution; and
- Scope for significant growth in services in operation flowing from the introduction of 5G.
Looking at these three elements today, we see that the first one appears to have been a good call. Telstra has subsequently announced a significant increase in its productivity targets and an acceleration in the timeframe for delivery of those targets. This element of Telstra’s strategy appears to be progressing well.
In relation to the other elements of our thesis, however, it is too early to tell. It is possible that other investors are increasingly looking past the NBN earnings hole at future growth potential and that this is influencing the share price, but it will be some time before we can say with any confidence whether these parts of the thesis were correct.
It is also fair to say that some luck has been on our side. The disruption caused to by the ACCC’s opposition to the TPG-Vodafone merger is in our view clearly beneficial to Telstra, which now has an easier run at establishing early leadership in 5G. We never expected to see TPG becoming a particularly effective competitor to Telstra in mobile given capital constraints, and so think that the ACCC action is more likely to hobble Vodafone than to lead to a 4-player industry structure, particularly with TPG having announced the abandonment of its mobile aspirations.
In summary, we can perhaps give ourselves a small pat on the back in respect of the first leg of our thesis, but the rest of the thesis is a longer-term proposition, and luck has played a part.
Some of the appeal is now priced in
Looking forward, not much has changed in respect of our thinking on these potential upsides. We continue to see opportunities for Telstra to improve its earnings in the medium term, but some of the appeal is now factored into the higher share price.
We remain happy to hold Telstra at the current level, particularly in a market where value opportunities are thin on the ground, but given the price rise the case is not as compelling as it appeared a year ago. Also, execution remains key, and we will be watching full year results closely for indications of progress against strategic goals, as well as information that might cause us to modify our medium-term forecasts.
Long term upside (and a potential takeover offer)
Another potential opportunity that shares some elements in common with Telstra is health care provider, Healius (HLS). Healius operates pathology, medical centre, diagnostic imaging and day hospital businesses with good market positions and appealing long-term growth potential.
Not unlike Telstra, Healius has seen painful declines in its profitability and share price as industry conditions changed faster than the company did. We think that at the current price, the market may not be expecting a lot from management’s turnaround efforts. However, we are inclined to think that management is taking the right steps to reduce costs and improve profitability, and that the eventual results could pleasantly surprise Healius shareholders.
The turnaround process for Healius is likely to take some time to play out, but we also note that major shareholder, Jangho, is thought to be contemplating a revised takeover approach, having been rebuffed last year at an indicative price of $3.25 per share. We suspect that Jangho also see long-term upside in Healius’ portfolio of businesses and may be willing to pay a premium to secure control over the realisation of that upside. To us, this looks like an interesting long-term story with corporate interest providing some additional option value.
Thanks Harry. I’m sure 5G will facilitate many new use cases that are hard to predict today.