Is Now The Time To Invest In Vodafone Group plc, Inmarsat plc And Gamma Communications plc?

Maybe recent stock market weakness has exposed better value in the communications sector. Today I’m looking at Vodafone Group (LSE: VOD), Inmarsat (LSE: ISAT) and Gamma Communications (LSE: GAMA).

Where are the emperor’s clothes?

Vodafone paid for last year’s dividend by taking on more debt. The firm has good cash flow, but invests most of it to try to stay ahead of the game. Mobile communications is a competitive business, and the firm’s growth depends on throwing money at infrastructure and new initiatives to keep up with technological advances and changing customer expectations.

Last year, Vodafone declared its free cash flow to be £1.1 billion. The dividend payout that year, though, came to just over £2.9 billion. Despite all the cash the firm generated through operations, the dividend and capital expenditure to grow the business led to an £8.5 billion shortfall financed by debt. Net borrowings ended the year at £22.3 billion — around 11 times that year’s operating profit. Free cash flow was a chunkier £4.4 billion the year before, and the directors expect capital-intensity to reduce going forward, but the figures show how the firm is ploughing funds back into the business. Those holding the shares now must hope that investment will pay off with bigger earnings later.

The shares are down 19% from highs achieved in the Spring. They need to be, and not just because it’s clear that Liberty Global won’t be bidding for the company. Vodafone’s valuation seems too high. I don’t feel it should be necessary to look so hard for justification of the current share price. The forward price-to-earnings ratio (PER) runs at just over 33 for year to March 2017, yet City analysts expect earnings to grow just 19%, and those earnings will fail to cover the dividend payment by around 50%, making the 5.7% yield seem like an empty box, a box that free cash flow could find hard to fill. There’s a lot of expectation for growth built-in here, so I’m avoiding, in case it doesn’t work out.

A well-defended trading niche

It’s not easy, or cheap, for a competitor to launch a satellite so that it can compete with the services provided by Inmarsat. There are high barriers to entry into the sector and Inmarsat enjoys a well-defended trading niche.

The firm started in 1979 to enable ships to stay in constant touch with shore, or to call for help in an emergency, no matter how far out to sea. Today, the company serves many sectors – typically, businesses and organisations that need to communicate where terrestrial telecom networks prove unreliable or unavailable.

Inmarsat’s tasty economics drive a high valuation, perhaps justified by the defensive, cash-generating nature of the business. Recent market turmoil hardly touched the shares, and the firm’s forward PER runs at 28 for 2016, with City analysts expecting a 21% uplift in earnings that year. There’s a 3.6% forward dividend yield on offer with the payout covered once by expected earnings. Inmarsat’s defensive credentials appeal to me, and I’m far more likely to take a chance on the firm’s shares than I am with Vodafone’s.

One to watch?

With its market capitalisation of £294 million, AIM company Gamma Communications is the smallest company featured. The firm is a technology-based provider of communications services to the UK business market. Gamma aims to meet the increasingly complex voice, data and mobility requirements of businesses. The firm’s offering includes cloud PBX, inbound call control services, SIP trunking, business-grade broadband, ethernet, mobile and data services.

More than 80% of Gamma’s revenues arrive via a network of around 780 channel partners. The remaining revenue comes via direct sales into specific market sectors. Organic growth since 2006 has been driven partly by repeat revenues, the firm reckons.

The shares are tearing upwards. The forward PER sits at just under 19, and there’s a forward dividend yield running at 2% or so, with the payout covered more than twice by expected future earnings. This is one to watch, I think, and could be attractive if the shares pull back from the current 358p.

Of the three featured here, I reckon Inmarsat is a share worthy of holding for a very long time. If you like shares like that, you'll be interested in the Motley Fool's free special wealth report called Five Shares To Retire On , which targets the investing ambitions of  long term investors like you and me.

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Kevin Godbold has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.