VALUE INVESTING

Big Tels

By Stephen Bland (TMFPyad)
March 24, 2006

Having taken a look at the bank and oil sectors in the FTSE100 over the last couple of weeks, because both are generally undervalued compared with the index, today I'm investigating the telecom sector for similar reasons. There are actually two official telecom sectors, fixed and mobile, but I'm treating them as one because there are only three companies anyway and a phone is a phone as far as I'm concerned. If anyone is interested, Vodafone is the mobile and the other two are the fixed operators.

The table, which I've arranged in order of capitalisation, shows some typical value ratios. As usual P/E and Yield are consensus forecasts and the rest are historical based on the last annual balance sheet. P/S is Price/Sales and P/CF is Price/Cashflow.

Company	Price	P/E	Yield	P/TBV	Debt %	P/S	P/CF
Vodafone (LSE: VOD)	128p	12.2	4.1%	5.5	9.2	2.5	6.7
BT Group (LSE: BT.A)	235p	11.9	5.4%	6.5	322	1.1	4.3
Cable & Wireless (LSE: CW.)	110p	20.6	4.2%	1.7	-73	0.8	8.5

Vodafone is by far the biggest of the three, capitalised at roughly £77bn with BT at £20bn and C&W possibly about to be dropped from the index at only £2.6bn. In fact Vodafone is so big that it is the fifth largest company in the index at present.

With the FTSE100 on a yield of 3.1%, these three are all yielding well over the average with BT some way ahead of the other two. With the index P/E at 12.7, C&W is substantially overvalued whilst the other two are slightly undervalued. Looking at assets neither Vodafone nor BT are attractive but C&W does have a much cheaper rating. It's not an asset play though because it is still valued at more than book.

There are huge variations in the debt levels. C&W has that value player's dream, net cash, whilst Vodafone is only very modestly geared. BT though has a stupendously high level of debt that in many other businesses would be considered crippling. However the company has made great strides in recent years in reducing this. Interestingly, though BT has the highest debt by miles, it has the lowest P/CF which I guess is as it should be under the circumstances. On P/S C&W is the cheapest by some way whilst Vodafone sticks out as being much dearer than the others.

So if you are interested in telecoms as value plays, which of these might be the most attractive? There's no clear candidate in the table because each share displays some aspects of value yet none are more attractive than the others on all or even most counts. Worse than that though, each company whilst having some clear value features, has some equally clear anti value features. Vodafone has modest debt but the highest P/S and the lowest yield. BT has the highest yield, the lowest P/CF but eye watering debt. C&W has net cash, the lowest P/S, the lowest P/TBV but a high non value P/E.

Turning to forecast eps, often the potential outer in value plays, Vodafone is roughly static over the next couple of years going from an actual 10.6p in 2005 to 10.4p in 2006 and 10.5p in 2007. BT shows a rising pattern going from 17.8p in 2005 to 18.8p in 2006 and 19.6p in 2007. A decline is indicated for C&W with an actual 8.73p for 2005 dropping to 5.72p for 2006 and 5.34p for 2007.

The dividend forecasts for all three companies show quite good increases over the next couple of years of 10-12% per year, surprisingly perhaps even for C&W despite falling eps.

It's a difficult call between these three. I hold BT, both as part of a long term high yield portfolio and also a further chunk as a value play, though the latter is only a relatively small side bet in my value trading portfolio. Value players will differ in the emphasis they put on the various ratios and it is how they see this that will decide which of these shares is the most attractive. There is no clear winner but one attractive feature of Vodafone is that it is undergoing something of a reorganisation by ridding itself of some of the portfolio of expensive foreign acquisitions made earlier. Just as acquisition is the enemy of value, divestment is its friend. As I say it's a close call though.

Of the shares mentioned Stephen owns BT.