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The latest emerging telco to score a broker “buy” recommendation

The telecom sector is abuzz with the takeover proposal for Superloop Ltd (ASX: SLC) and the recent surge in the Telstra Corporation Ltd (ASX: TLS) share price.

But these aren’t the only stocks to be watching. There’re opportunities among the smaller listed telcos as well with Canaccord initiating coverage on Spirit Telecom Ltd (ASX: ST1) and slapping a “buy” on the small cap stock.

The ST1 share price zoomed up 6% to 18 cents during lunch time trade as the SLC share price added 4.7% to $1.90 after the company received a takeover bid from the Queensland Investment Corporation.

The TLS share price is also winning support with the stock jumping 0.9% to $3.39 at the time of writing, which takes its 2019 gain to 22%, which is nearly double the gains on the S&P/ASX 200 (Index:^AXJO) (ASX:XJO) index.

The telco with big growth potential

But Spirit Telecom could be where the best gains are this year if Canaccord is on the money. The broker believes the acquisitive Melbourne and Gold Coast focused telco offers far better growth potential than its larger peers.

“Australia’s telecom services market is dominated by five large players. The large players are struggling for revenue and earnings growth due to margin erosion from the NBN rollout as well as competition,” said Canaccord.

“Industry analysis suggests that ‘second tier’ players are gaining share, albeit at a very low level, with a share approaching 1.5% in 2019. That would still mean c$600-700m revenue on offer for those outside the ‘Big 5’ and offers scope for growth among those players building scale.”

On the re-rating path?

The bullish take from Canaccord couldn’t come at a better time for Spirit Telecom after management posted a disappointing first half result in February that sent the stock crashing to a low of 10 cents.

However, Canaccord thinks the past is the past and Spirit Telecom is in good shape to return to growth and that its acquisition of LinkOne is particularly important to the small cap scoring a re-rating.

“[LinkOne brings] useful revenue and earnings to ST1 at a reasonable price, its existing infrastructure assets provide the opportunity for ST1 to access new markets in Brisbane and Sydney,” said the broker.

“We expect a materially stronger 2H19 from ST1 with that momentum continuing into FY20 and FY21, with Commercial revenues the key drivers of organic growth.”

If Spirit Telecom can deliver the growth Canaccord is counting on, the stock should trade at a premium to the sector and that’s why the broker has put a 25 cent per share price target on the stock.

That’s close to a 40% upside, which is far better than what you can expect from its bigger rivals even on a good day. But that’s assuming you are comfortable with the volatility and higher risk profile of Spirit Telecom – aptly named given it needs “animal spirits” to come alive on the market to win that coveted share price re-rating.

If you are looking for other higher risk, higher return opportunities on the ASX, you will want to read this free report from the experts at the Motley Fool.

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Brendon Lau owns shares of Telstra Limited. The Motley Fool Australia's parent company Motley Fool Holdings Inc. owns shares of SUPERLOOP FPO. The Motley Fool Australia owns shares of and has recommended Telstra Limited. The Motley Fool Australia has recommended SPIRIT TC FPO and SUPERLOOP FPO. 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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