Why I’d dump Telit Communications shares and buy this FTSE 250 growth and dividend stock instead

Telit Communications plc (LON:TCM) shares have been recovering, but this strongly cash generative FTSE 250 (INDEXFTSE: MCX) stock could be a better buy.

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Shares in Telit Communications (LSE: TCM) gained a few percent Wednesday after a first-half update told us to expect revenue of around $201m, with gross profit margins apparently having “stabilised following the declines seen in 2017.

Chief executive Yosi Fait told us that “we are making headway towards a return to being a sustainably cash generative business.”

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The firm, which bills itself as “a global enabler of the Internet of Things,” saw its share price collapse in 2017, from 375p in April to only 102p by August. At 160p now, they could be on the way back, but what had previously gone wrong?

The market was shocked in August 2017 by the revelation that chief executive Oozi Cats had previously been indicted on fraud charges in the US and had withheld that from the Telit board.

As my colleague G A Chester explained, the firm suffered a breach of its debt covenants, and there was some interesting director dealing around that time. He also pointed out that the company’s impressive recorded profits were not, at the time, feeding through to cash flow.

Steering clear

After the share price slid a little, I’d thought the shares looked good value. But what a mistake that was, just a month before the news of Oozi Cats broke. There’s a lesson for me there, which applies to upcoming growth stocks. It’s common to see EPS growth and rosy forecasts, but it’s often not so easy to see actual cash in the early days — it’s often something we hope to see tomorrow.

The fact that Telit had already started paying dividends possibly also blinkered me to the troubles ahead, and with hindsight the company was paying out cash it couldn’t yet afford. The dividend was curtailed last year and there’s no sign of any resumption on the cards up to 2019.

Telit is very much a ‘once bitten’ stock for me now.

Second chance

If you want a FTSE 250 telecoms company that has done everything right and has been well managed, you might like the look of Telecom Plus (LSE: TEP). I was a big fan of Telecom Plus, which provides bundled telecoms and utilities services under its Utility Warehouse brand, in the early days. But we saw a typical growth share bubble, with everyone wanting in and pushing the share price up way too high. Peaking close to the 2,000p level, the resulting P/E multiples of around 40 were just not sustainable.

Now the price has fallen back to more realistic levels at around 1,150p, I’m starting to like the look of Telecom Plus shares again.

Results for 2017, released in June, showed a modest 3.4% rise in adjusted EPS, and the dividend was lifted by 4.2%. The latter is really what appeals to me, with the firm saying it “remains committed to a progressive dividend policy consistent with the underlying strong cash generation of our business.

Forecasts suggest a stronger 9% rise in EPS this year, with the dividend yield set to grow to 4.5% — and to 4.8% by March 2020. Cover won’t be dramatic at a little under 1.2 times, but the clear visibility of revenues in the utilities sector means I’m happy with that.

Telecom Plus enjoys bulk-buying advantages which should help it compete successfully with other smaller utilities firms, and I see forward P/E multiples of 18 to 19 as representing good value now.

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Alan Oscroft has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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