As the prospect of an economic downturn sends chills through share markets, it's worth thinking about what goods and services are essential to Australians.
After all, when consumers have less to spend, discretionary items are the first to be cut. If a service or product is important enough, then the customer will do their best to set aside some cash for it.
For Wilsons head of investment strategy David Cassidy, access to the internet has now become a utility.
This is why he likes the look of Telstra Corporation Ltd (ASX: TLS) shares at the moment.
"In the modern world, digital connectivity is all but essential," Cassidy said in a memo to clients.
"This helps support consistent user demand for mobile and fixed network plans from leading telcos such as Telstra through the cycle, while the company's owned infrastructure (eg fibre, ducts, mobile towers) provides annuity-like cash flows that are even more predictable."
Unlocking valuable infrastructure
In recent times investors have shown tremendous interest in infrastructure assets.
Telstra is trying to take advantage of this by separating out its infrastructure side from the consumer-facing business, according to Cassidy.
"This will position the company to realise shareholder value that has been hidden in the previous amalgamated structure, given the strong institutional investor demand for strategic infrastructure assets, which typically command substantially higher earnings multiples as pure play investments."
The S&P/ASX 200 Index (ASX: XJO) telco has already sold off its mobile towers for $2.8 billion, which was the equivalent of an enterprise-value-to-EBITDA multiple of 28.
"[That's] a substantial premium to Telstra's current trading multiple of ~7.9x," said Cassidy.
"Around 50% of the net proceeds of the deal were returned directly to shareholders."
The "next logical candidate" for spinning off is InfraCo Fixed, which generates more than six times the earnings of the mobile towers.
"We believe the capital raised by future asset divestments will help to underwrite Telstra's ordinary dividend payments while delivering incremental value to shareholders by funding large capital management initiatives like special dividends and share buybacks."
Telstra shares are cheap right now
The Wilsons team prefers to analyse Telstra's valuation using cash earnings over statutory earnings.
Cassidy explained this is "because the company's CAPEX is expected to be structurally lower than its depreciation and amortisation over the medium-term, given historically higher CAPEX and the mix of asset lives".
"Therefore, cash flow provides the best measure of Telstra's underlying performance and is likely to remain ahead of accounting earnings."
Using this metric, Telstra shares are trading on a 12-month forward enterprise-value-to-EBITDA ratio of 7.9 and a price-to-equity-free-cash-flow multiple of 16.4.
"This looks attractive relative to other ASX defensives, and given the expected recovery in the company's earnings and the significant intrinsic value embedded within its infrastructure assets that is likely to be unlocked over the medium term."
Telstra shares have lost more than 7% year-to-date and currently pay out a 2.8% dividend yield.
