Is Now The Right Time To Buy Talktalk Telecom Group PLC?

Will TalkTalk Telecom Group (LSE: TALK) be forced to pay millions of pounds in compensation to customers who might have suffered loss or distress after having their bank details stolen?

Reports that the firm could face up to £20m of compensation claims helped push the shares 9% lower on Monday morning. TalkTalk stock is now 21% lower than it was one week ago.

The question for investors is how badly the firm’s growth will be affected by last week’s attack.

Is TalkTalk now cheap enough to buy?

Slamming the brakes on

We don’t yet know how many customers will leave TalkTalk as a result of the latest security breach.

We don’t know how many potential new customers will decide to go elsewhere.

However, current forecasts for earnings per share growth of 95% in 2015/16 and 56% in 2016/17 now seem quite optimistic to me. The firm also faces the risk of compensation claims which could cost up to £20m, according to recent reports.

Another concern is that TalkTalk seems to have an ongoing problem with security. This is apparently the third cyber attack the firm has suffered in the last year.

TalkTalk’s reputation has been damaged. To win back customer loyalty, the firm may need to invest heavily in improving its IT security.

Was TalkTalk a buy before last week?

TalkTalk shares were not exactly cheap before this scandal emerged, in my opinion.

Based on the current share price of 233p, TalkTalk trades on a trailing P/E of 28 times 2014 adjusted earnings per share.

Looking ahead, the valuation appears to be a little more reasonable. TalkTalk shares have a 2015/16 forecast P/E of 17, falling to 10.7 in 2016/17.

The problem with these forecast valuations is that they depend on TalkTalk’s earnings per share rising by nearly 200% over the next two years. This now seems unlikely, in my view.

The dividend problem

The final problem is TalkTalk’s dividend. One factor supporting the share price before last week’s crash was TalkTalk’s generous dividend policy. Last year’s payout was 13.8p per share, giving a yield at today’s share price of about 6.0%.

The problem with this is that TalkTalk isn’t generating this kind of cash.

Last year’s 13.8p dividend was almost twice the firm’s adjusted earnings per share of 8.2p. Adjusted free cash flow of 9.4p didn’t cover the dividend either, and actual free cash flow was much lower than this. TalkTalk’s net debt rose by £92m to £589m last year.

TalkTalk’s dividend already looked stretched to me before last week’s cyber attack.

If the firm faces compensation costs and slowing growth as a result of last week’s events, then I suspect a dividend cut is likely.

Wait a little longer

TalkTalk does have a viable business and a valuable customer base. A takeover bid remains possible.

However, the shares don’t look like a bargain to me at the moment, especially given the firm’s high level of debt. I’m going to wait and see if they fall further before considering whether to buy.

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Roland Head 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.