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Top broker slaps sell rating on TPG Telecom Ltd shares

The TPG Telecom Ltd (ASX: TPM) share price will be on watch on Thursday after it was the subject of a bearish broker note out of one of Australia’s leading brokers.

This could put further pressure on the telco company’s shares which are already down close to 18% year-to-date.

What did the broker say?

According to a note out of Goldman Sachs, its analysts have downgraded TPG Telecom’s shares to a sell rating and slashed their price target by 20% to a lowly $4.70.

This price target implies potential downside of almost 13% from its last close price.

Five reasons have led to the broker making the move. These are that its core business is under pressure, mobile execution risk, regulatory risk, a fully geared balance sheet, and a stretched valuation.

In respect to its core business, the broker appears concerned by deteriorating margins and increasing competition in the broadband space. It pointed to TPG Telecom’s declining subscriber numbers in the first-half of FY 2018 as evidence of this and notes recent NBN launches by Exetel and Kogan.com Ltd (ASX: KGN).

In addition to this, the broker appears concerned by the fall in its existing mobile subscriber base through its mobile virtual network operator (MVNO) offering. Considering Australia has some of the lowest data prices and highest quality mobile networks globally, Goldman thinks the company may struggle to differentiate itself when it launches its own network offering.

It does, however, acknowledge that its mobile network could be an opportunity for the company to bypass the NBN in the future with a 5G offering. Incidentally, I think this could be the main reason that TPG Telecom has launched its own network and believe 5G could overtake the NBN eventually.

Finally, in terms of valuation, the broker thinks that TPG Telecom’s premium over industry competitors such as Telstra Corporation Ltd (ASX: TLS) is unjustified given its growth profile and that a rerating is necessary.

I think Goldman has a point here. It estimates that TPG Telecom’s shares are changing hands at 17.3x FY 2019 earnings compared to 10.4x for Vocus Group Ltd (ASX: VOC) and 9.1x for Telstra. It is worth noting that the broker has a neutral rating for Vocus and conviction buy rating on Telstra’s shares.

What now?

I would have to agree with the majority of Goldman’s points and plan to stay clear of TPG Telecom’s shares for the time being. Instead, I would consider buying Telstra’s shares because of their sizeable decline over the last 12 months and the generous dividend yield they offer.

But if you're not keen on the telco industry right now then you could consider these top growth shares instead.

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Motley Fool contributor James Mickleboro has no position in any of the stocks mentioned. The Motley Fool Australia owns shares of and has recommended Telstra Limited, TPG Telecom Limited, and Vocus Communications Limited. The Motley Fool Australia has recommended Kogan.com ltd. 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 Scott Phillips.

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