September was a month to forget for shareholders of telecommunication stalwarts Telstra Corporation Ltd (ASX: TLS), TPG Telecom Ltd (ASX: TPM) and Vocus Communications Limited (ASX: VOC) as the S&P/ASX 200 Telecomms Index (ASX: XTJ) shed 6% over the month (and has slumped over 16% since July).
The fall comes despite the broader S&P/ASX 200 Index (ASX: XJO) rising 4.5% over that time, indicating sector-specific concerns are behind the fall.
Here's my take on why shares in the three leading telcos have been smashed.
Telstra
A concern plaguing the telecommunications sector is the roll-out of the National Broadband Network (NBN) by NBN Co. In April this year, Telstra signed a mammoth $1.6 billion deal with NBN Co to build and upgrade the hybrid fibre-coaxial networks which will be used to provide NBN services to customers. The capital expenditure costs associated with this upgrade appear to be a headwind to Telstra's share price as profitability appears to be declining in the mature telecommunications sector. Accordingly, investors are weary of the return this extra capital expenditure will generate for the company.
Even so, I rate Telstra as a buy in the sector, given its industry-leading position as Australia's largest telecommunications provider. Despite its service hiccups over the last 12 months and potential for it to lose the Government tender for Australia's triple-zero service, Telstra's strong balance sheet and recent share buy-back should allow it organically lift earnings per share and support its current share price.
With its industry leading fully-franked yield of 6.1% and shares changing hands near multi-year lows, Telstra is my pick in the sector.
TPG Telecom
TPG appears to be a victim of its own success as rampant industry consolidation fuelled blockbuster growth for many years. However, with the telecommunications sector now heavily controlled by a few major players, growth opportunities are few and far between, meaning profit growth is likely to slow. This is one of the key reasons for TPG's 30% slump in price since reporting results in September.
Despite posting a 75% increase in earnings (EBITDA) and a 69% increase in net profit after tax (NPAT), the explosive growth rates were a product of its iiNet acquisition – an organic outcome. As guided by management, 2017 earnings growth is likely to moderate to 6%, meaning its current price-earnings of 18x trailing earnings demands a higher multiple than industry peers. Accordingly, investors are better off waiting for a better entry point before buying shares in TPG, in my opinion.
Vocus
Vocus' shares hit 52-week lows of $5.52 on Thursday as a sell recommendation from Hong Kong investment bank CSLA saw investors head for the exit. With Vocus also experiencing the same organic growth benefits (and future growth problems) as TPG, Vocus' shares appear richly valued given the industry outlook.
Although Vocus' telecommunications infrastructure networks and recent merger with M2 should insulate earnings somewhat, it's growth path beyond the 2018 financial year remains unclear. As such, Vocus' current price-earnings of about 19.5x fairly values the business fairly, in my view. Investors should hold the stock and buy if its share price declines further.
Foolish takeaway
After years of consolidation and mega-mergers, the Australian telecommunications industry is at an inflexion point with growth likely to trend to average over the coming years. As such, investors in the sector are best served seeking companies which provide sustainable returns and offer moderate prospects of growth.
In my mind, this makes Telstra the pick of the bunch given its strong balance sheet, high dividend yield and ability to organically lift earnings further.
