The Motley Fool

The Death of Telstra

There might be better places for your investment…

Telstra (ASX: TLS) is one of the most widely – and most controversially – followed companies trading on the ASX today. Whether it’s the mainstream media or the brokers and analysts, everyone has an opinion.

Originally part of the Postmaster-General’s department, after many iterations of structure and ownership, Telstra was privatised in three tranches between 1997 and 2006.

Many of those shareholders are still sitting on paper losses from the privatisation, especially those who purchased shares in the second tranche sale at $7.40.

Telstra is often on the short-list for people who are looking to either add a blue-chip investment to their portfolio, or as an investment in the telecommunications sector.

That’s understandable.

With a 46% market share, Telstra is still far and away the dominant telecommunications provider in Australia today – both before and after the NBN is taken into account. They have a massive lead in market share and brand recognition, and a decades-long income stream to come from the NBN, should it come to pass.

All of those benefits are undoubtedly positive for Telstra. It’s also likely that the development of technology will continue to open up new markets for telecommunications companies, and Telstra will be in the box seat to take advantage.

That said, we believe Telstra may NOT be the best place for your blue-chip or telecommunications investment today.

Telstra’s future success is far from guaranteed. The path of technology is uncertain, the actions of competitors are unknown, and Telstra will never be far from the impact – for good or ill – of government policy.

In short, even with the share price down a long way from its all-time high over $9, the potential upside from here may not be enough reward.

Instead, consider taking the things that you like about Telstra – be it the size and scope of an Australian blue chip, or an investment in the telecoms industry that will be front and centre of the economy throughout the next few decades and beyond – and get them in two companies that we think could do even better from here…

Big, Impressive and Growing

We don’t blame you for wanting to stick with a well-known, Australian household name, with an impressive history. But that’s not enough.

Sure a 28c dividend is tempting, but it hasn’t increased in years. Everyone knows Telstra – and many love its services (and some don’t!), but the same was true of Angus & Robertson bookshops once upon a time. Brand recognition alone isn’t enough to guarantee success.

Pay up for Culture

Tom Gardner, co-founder and CEO of The Motley Fool has long talked about the value of great management, and he’s right. Visionary, shareholder-friendly managers with energy and integrity can really deliver results for investors. Companies that have been around for almost a century don’t have the luxury of a single CEO, but great companies can deliver the next best thing – a company culture that embodies that same spirit.

Woolworths (ASX: WOW) has many great things going for it, but arguably the most sustainable is a very impressive culture. One of our colleagues here at The Motley Fool has had first hand knowledge of both store and head office culture (a few years ago), and can attest to that very fact.

Woolworths, where possible, promotes staff from within its own ranks. Not only that, but the vast majority of its senior staff – in both operational and merchandising roles – started their careers on the shop floor.

The incoming CEO, Grant O’Brien is a 24-year veteran with the business, and the incumbent, Michael Luscombe, has been with the retailer for over three decades. Immediate past CEOs Roger Corbett and Reg Clairs were cut from a similar cloth.

That pattern is replicated in Woolworths stores and offices around the country. The proportion of their staff with over 20 years service is staggering. In some companies or government departments, that would be cause for concern, but far from becoming complacent and entitled, the Woolworths culture ensures these people continue to embody the best of the business.

A Large Slice of Australian Retail

Over the 85+ years that Woolworths has been in business, their retail empire has grown to cover most aspects of the Australian retail landscape.

Whether its namesake supermarkets, Big W general merchandise stores, Dan Murphy, BWS or Woolworths Liquor bottle shops, Dick Smith electronics stores as well as petrol canopies and their upcoming hardware offering, you don’t have to go far to shop at a Woolworths-owned store.

Woolworths it a well-run business, and its results bear out that reputation. Across the group, Woolworths delivered sales of $54.1 billion in the most recent financial year (to June 30, 2011), up 4.7% on the prior year. Woolworths achieved a Net Profit of over $2 billion in the 2010 financial year, with 2011 likely to be around 5% – 8% higher (based on management’s guidance).

Growth, Profit and Downside Protection

Woolies constantly delivers great returns on shareholders funds, and has managed to turn cost reductions and sales growth into both price reductions for customers and more profit for shareholders.

And the company has staying power. Despite economic downturns, skittish consumers and resurgent competitors (most notably the reinvigorated Wesfarmers (ASX:WES)-owned Coles), Woolworths continues to bring more people into their stores, and encourages them to part with more of their money.

In part, it’s the nature of the business – reluctant consumers might eat out less, but they have to keep buying groceries – but it’s also a testament to the retailer’s management and board.

Year in, year out, Woolworths has focussed on improving the retail offer for its customers, building the value of its retail brands and a relentless approach to cost management, especially in its supply chain.

Profit from The Fresh Food People

Woolworths shares are currently trading at around $27, a similar price to 4.5 years ago, despite growing profits at an average of almost 18% per year since then. At that price, they trade on a forward price to earnings ratio of around 15 or 16, and a fully-franked dividend yield of around 4.5%.

With a stable and high return on shareholders funds of 28%, it’s business as usual at Woolworths. The only thing that has changed is investor’s perception. The following chart highlights the P/E (PER) compression of Woolworths’ share price over the last four years.

Source: Capital IQ, a division of Standard & Poor’s.

If you’re looking for a top-flight Australian business, with the brand, culture and management to match, it’s very hard to go past Woolworths, especially at today’s price.

Going Truly Mobile

Dividend yield? Check. Limited downside? Check. Iconic Australian brand? Check.

Sure, we’ve covered off many of the reasons you either bought Telstra or would consider doing so. And Woolworths fits the bill very nicely, thanks.

But perhaps you have other reasons for considering Telstra. Technology is racing ahead, mobile internet connectivity is truly flourishing and the future is a data-rich one with ever more devices and more of our lives being lived online.

If that’s your rationale for considering (or holding) Telstra, we can’t blame you. But, along with Woolworths, there is another business that might be poised to deliver better returns than Telstra.

What if we told you there was another business that you could do well buying – even if its performance got worse! Because that’s exactly the margin of safety that we think this stock offers.

Buying into the Future

You already know the opportunity for telecoms companies with the uptake of 3G mobile technology – and the more tech savvy among you will have already read about the coming next generation – 4G – mobile technology.

All of that is on offer in a market with very, very low 3G penetration currently. The market we’re talking about is the most populous nation on earth. Even better – this stock is the world’s largest telecom company!

By now, you might have put two and two together – the world’s largest telecoms business is none other than China Mobile (NYSE: CHL).

China Mobile had nearly 617 million subscribers at the end of June 2011 – well over 25 times the entire population of Australia! They have 69% market share, and the market has only 64% mobile penetration – the vast majority of it still using 2G technology.

Can I Do That?

Before you read any further, you may have noticed that China Mobile’s ticker is a New York Stock Exchange (NYSE) listing. A Chinese company, it is listed on the NYSE through the use of American Depositary Receipts (or ADRs).

ADRs are simply a mechanism through which non-American companies can have their shares traded in the world’s biggest capital markets – the US. Quite a few Australian companies, including BHP Billiton (ASX: BHP, NYSE: BHP), Westpac (ASX: WBC, NYSE: WBK) and Rio Tinto (ASX: RIO, NYSE: RIO) trade on the NYSE this way.

In this quickly globalising world, Australians can – with a little work – trade shares on international exchanges. Most of the major Australian brokerage houses (such as CommSec and E*Trade) have an international trading desk, and there are some Australian branches of US brokers (such as OptionsXpress) who will facilitate trading in the US and other countries.

It really is quite simple if you just follow the process, and the 98% of the world’s stock market capitalisation that is outside Australia (yes, we’re just 2% of the combined global stock market capitalisation) is open to you.

(You do need to be aware of the currency implications of investing in shares denominated in another currency (in this case US dollars) – your returns will be based on the movement of the shares and the change in the exchange rate during the period you hold the shares).

Poised for Growth, Priced for Decline

China Mobile had nearly 590 million subscribers at the end of January, making it the largest telecom company in the world. It has 69% market share in a massive market that’s just 64% penetrated.

China Mobile isn’t the only telecoms business in China. It’s not even the market-leader in 3G subscriptions at the moment. But as we alluded to earlier, the investment case here doesn’t rely on outsized business returns. In fact, the numbers still add up if China Mobile’s performance suffers relative to the competition.

If… market share drops from 69% to 60%, AND it signs up less than half of all new subscribers AND EBIT margins decline from 50% to 40%… trading at under $50, the stock is still around 10% under fair value.

Nothing in life is certain – and we wouldn’t assert that’s anywhere near the case here. But it’s very unlikely that all of the three outcomes above happen at the same time, so our downside is pretty well protected. And if one or more of the variables above can be maintained or grows, we’ll do even better.

If we haven’t convinced you yet… China Mobile also pays a dividend that’s not far short of 4% (unfranked – dividend franking only applies to Australian companies, and only in respect to the company tax paid in Australia).

Cashing in on China Mobile

China Mobile is a dominant business with an enviable balance sheet in one of the world’s fastest-growing emerging market. Businesses like this generally sell for more than they’re worth, but now you have the chance to buy China Mobile – a company that will grow along with China’s economy over the next decade – at a discount to its fair value.

Take Stock

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Way back in 1997 I co-founded The Motley Fool UK. From modest beginnings, I built up the business into one of the most successful and recognised brand names in the UK financial sector.

In my 14 years at The Motley Fool, I’ve has written thousands of articles for the UK, US and Australian websites, and in 1999 also co-authored the best selling The Motley Fool UK Investment Workbook.

Now living back in my native Australia, I bring over two-decades of hands-on investing experience to the Australian public.

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All figures as at August 16th 2011