The defensive telecoms sector has been one of the few sectors that has put in a positive performance this year. For example, shares in Vodafone (LSE: VOD) and BT (LSE: BT.A) have returned 3% and 21%, respectively, this year including dividends, compared to a loss of around 3% for the FTSE 100.
And it’s highly likely that these companies could outperform again next year as demand for the two companies’ services continues to trend higher.
The cheaper pick
Choosing between BT and Vodafone depends on your investment style. Value investors are likely to sway towards BT, as it’s the cheaper of the two. On the other hand, income investors might prefer Vodafone. Here are the key figures.
BT currently trades at a forward P/E of 15.5. Earnings per share are expected to fall by 3% this year but rebound 7% during the company’s next fiscal year. BT currently supports a dividend yield of 2.6%, and analysts expect the company to hike the payout by 5% per annum for the next two years, leaving the company with a dividend yield of 3.5% for 2016/17.
Vodafone currently trades at a forward P/E of 45.6. City analysts expect Vodafone’s earnings per share to increase 20% during 2017, which indicates that the company is trading at a 2017 P/E of 38.7. Vodafone’s dividend yield stands at 5.3%.
However, if you’re not attracted to either of these companies, their smaller peer, KCOM (LSE: KCOM) might peak your interest.
Surprising move
Kcom recently surprised shareholders by announcing that it was selling its national network infrastructure outside of Hull and East Yorkshire to AIM-listed CityFibre Infrastructure Holdings PLC for £90m.
This was a game-changing deal for Kcom for two reasons. Firstly, the cash infusion will allow the group to pay down debt and rebuild its balance sheet. For the six months to the end of September, Kcom reported net debt of £103m and a pensions liability of £16.1m. Pension contributions are set to cost the group £2.7m per annum for the next few years while debt interest costs are around £3m per annum. So, depending on how Kcom’s management splits the cash infusion, it’s clear that the group’s income will receive a boost from the lower financing costs. Management has already pointed out that on a proforma basis, group net debt has dropped to £13m following this deal.
Better returns
As well as reducing debt, Kcom will be able to reinvest some of the cash received from the sale of its network infrastructure. It’s highly likely that Kcom will be able to reinvest the capital into assets that generate a higher rate of return than was possible with the network infrastructure. Indeed, telecoms infrastructure is notoriously expensive to build, but margins tend to be razor-thin. Selling low-margin networks to free up cash to reinvest in higher-margin services is quite common in the telecoms industry.
Kcom’s shares currently trade at a forward P/E of 13 and support a dividend yield of 5.9%. The company’s shares could be in for a significant re-rating as the group pays down debt and reinvests in higher margin services.
