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Kick Off: Telstra Corporation Ltd v Suncorp Group Ltd

Australia’s giant telco, Telstra Corporation Ltd (ASX: TLS) takes on, Suncorp Group Ltd (ASX: SUN), in the Round of 16 of the ASX World Cup. Crowd favourite Telstra will likely be favourite against an up-and-coming rival in Suncorp – but could that underdog status be the edge Suncorp needs?

Pre-match commentary and stats

Suncorp Group is an insurance company with a significant banking business that is in the middle of a restructure that is expected to significantly boost earnings. The company was hit hard by the GFC, though its share price has rebounded 100% since 2009.

In comparison, Telstra hit a low in 2010 due to consecutive years of declining profits and a dividend payout ratio that crept above 100% in FY 2011. The stock price has more than doubled from its lows at the end of the 2010 calendar year as profits increased in large part due to surging mobile subscribers and corresponding revenue increases.

Telstra Suncorp
Market Capitalisation $65.45 billion $17.55 billion
Forecast FY 14 P/E ratio 16.2 17.8
Forecast FY 14 Yield 5.53% fully franked 5.97% fully franked
Forecast FY 15 P/E ratio 15.45 13.05
Forecast FY 15 Dividend Yield 5.53% fully franked 6.26% fully franked
Net interest cover 7.03 N/A
Current P/B ratio 5.19 1.26

Notes: Thompson Consensus Forecasts, and Morningstar data

KICK OFF !

With the ball in play it no longer matters what the companies have achieved in the past – it’s all about the present price and future prospects. And when it comes to price, Suncorp surprises the crowd by going on the front foot early. While the dividend payout ratio may currently exceed 100%, Suncorp’s dividend yield of almost 6% is nothing to be sneezed at, although Telstra responds strongly with its own dividend yield of over 5.5%, backed by highly consistent cashflows.

On the other hand, for a $65 billion company, Telstra’s forecast FY 2015 P/E ratio of 15.45 looks a bit high, especially for a telco that uses considerable leverage in order to boost return on equity. In comparison, if analysts are correct, Suncorp will boast a relatively low P/E ratio of 13.05 by FY 2015. The probability of an increasing dividend from Suncorp gives the team the momentum it needs.

Suncorp scores an early goal on price to take the lead 1 – 0!

When play restarts after the half-time break Telstra’s competitive advantages come into play. Although Suncorp certainly has a brand, Telstra’s is far more widely known, and with a significant improvement in customer service in recent years, it has become immensely valuable. Furthermore the company owns ducts that are valuable to the government-owned NBN Co and smaller competitors such as iiNet Limited (ASX: IIN) and Vocus Communications Limited  (ASX: VOC). On the strength of this quasi-monopolistic competitive advantage, Telstra manages to sneak one past the keeper with a diving header.

The equaliser by Telstra brings the score to 1 – 1!

With the teams locked at 1 – 1 neither side seems willing to take many risks. Speaking of risks, the main risk with Telstra is that disruptive telecommunications technologies could undermine the value of the company’s existing copper network even faster than many consider possible. This could lead to a significant hit to cashflow and potentially put the dividend at risk.

On the other hand, Suncorp has major exposure to natural weather events and although Warren Buffett does not profess to be overly concerned about the impact of climate change on insurance operations, changes in climatic conditions definitely create additional challenges for insurers. Indeed, 66 insurance company CEOs have signed a statement warning that the “potentially devastating economic and social consequences” of climate change are “of great concern to the insurance industry.” Neither team’s defence gives in and the score is locked at 1 – 1 at the full time whistle.

Extra time – Kick Off!

When play restarts, both teams are more aggressive, but Suncorp’s growth initiatives may be threatened by impending drought in Queensland – agribusiness is important for Suncorp. In comparison, Telstra’s mobile revenues are picking up the slack resulting from the reduced relevance of copper connections. The company recently divulged that average revenue per user has stabilised, so new mobile customers are now contributing to the bottom line. To quote midfielder Warwick Bray, customers are “consuming more data,” and “choosing to upgrade their plans by data packs, etc.”

Combine this with the innovative plan to create one of the world’s biggest wi-fi networks and you have threatening growth prospects. The spectre of 2 million hotspots allowing broadband customers to use their allowance in multiple locations proves too much for Suncorp, and Telstra scores a goal late in the second half of extra time.

When the game ends, Suncorp supporters are saddened to see the jubilant Telstra players celebrate a 2 – 1 victory.

Warren Buffett famously looks for growing companies with sustainable competitive advantages. Certainly, Telstra has a few - the ducts, a huge network and of course the advantage of economies of scale... Our report on Buffett style investment can assist your judgement of companies like Telstra.

Telstra is a good company, but it is quite expensive -- there are better buys on the market. The Motley Fool has just published a brand-new investment report and your copy is FREE. Click here to discover Warren Buffett's investing secrets and two top ASX shares Buffett could love! Your copy is free when you click here.

Motley Fool contributor Claude Walker (@claudedwalker) owns shares in Vocus Communications.

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