Down 30%, are TPG Telecom Ltd shares a buy?

Telecommunications giant TPG Telecom Ltd (ASX: TPM) has been the subject of plenty of debate among investors recently.

Slammed for its weak set of earnings results recently, some investors have pointed out that now is the time to take your money off the table and run. Many in the telco sector have enjoyed enormous gains in recent years, but those days can only go on so long.

Others might argue that now is the time to buy. TPG Telecom’s shares were trading above $12 at the beginning of September, but have now plunged a little more than 30%. They fell 1.3% on Monday and ended the session at $8.51.

Source: ASX

Source: ASX

And if not TPG Telecom, then many investors would suggest its rival Vocus Communications Limited (ASX: VOC) is a buy. It too has plummeted from $7.69 at the beginning of September to a mere $6.13 today – a decline of 20%. That was, in large part, exacerbated by the recent resignation of its Chief Financial Officer, Mr Rick Correll, who has been with the group since the early days.

Correll will continue in the role for “the next few months”, indicating he is leaving on good terms. But some investors will still speculate his resignation could highlight potential issues with the integration of Vocus’ recent acquisitions, including M2 Group which it purchased earlier this year.

Under the leadership of the highly respected David Teoh, TPG Telecom has generated significant gains for investors – particularly those who bought in at the beginning of 2012, in part due to the consolidation that has taken place within the industry.

Four companies now dominate Australia’s telecommunications field, being Optus, Vocus, TPG Telecom and, of course, Telstra Corporation Ltd (ASX: TLS). It is difficult to see there being any more needle-moving acquisitions in the space anytime soon, which does diminish TPG Telecom’s ability to grow its top line.

That is a concern that investors, and potential investors, need to be wary of. In the financial year just completed, TPG Telecom reported 88% growth in revenue and underlying earnings (before interest, taxes, depreciation and amortisation, or EBITDA) grew 60%.

Those are some big numbers, but much of that was generated by its acquisition of iiNet. What’s more, EBITDA growth is expected to be muted in the current financial year, with guidance for growth of roughly 6.5%.

Should you buy TPG Telecom?

TPG Telecom has proven a great business, and that could well continue over the coming years. But the company could be transitioning into a more mature phase of its life, which could see growth continue at a much slower pace than what investors have become accustomed to.

In FY16, TPG Telecom achieved an underlying EBITDA margin of 32.4%, while its underlying net profit margin was a healthy 15.1%. Assuming the company maintains those margins in FY17, TPG could achieve a net profit of roughly $384 million based on the mid-point of its guidance. With around 848.5 million shares on issue, according to S&P Global Market Intelligence, that would represent earnings per share of 45.3 cents, putting TPG Telecom on a forward price/earnings ratio of almost 19x. Estimates from analysts following the stock are for 46 cents per share, according to The Wall Street Journal, down from 50 cents a month ago.

Despite its history for strong growth, 19x forward earnings isn’t cheap for a company whose growth is slowing down. That said, it’s also not so expensive that investors should immediately write the company off.

TPG Telecom shares have fallen in price and that represents an opportunity for investors to take a closer look at the business itself. But investors should do their own due diligence and determine for themselves whether they think there is still growth left in TPG Telecom’s tank, or if this growth story is over.

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Motley Fool contributor Ryan Newman has no position in any stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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