Large telecoms companies are a cross between technology stocks and utilities: the services they provide are nearly as essential as electricity, but we expect them to provide constant technical innovation and improvement.
I’ve taken a look at three of the UK’s biggest telecoms players, Vodafone(LSE: VOD) (NASDAQ: VOD.US), BT Group (LSE: BT-A) (NYSE: BT.US) and TalkTalk (LSE: TALK) to see how they compare and to decide which of them, if any, I’d buy in today’s market.
1. Dividends
Large telecoms stocks are usually long-term holdings, so dividends are important:
| Â | Vodafone | BT Group | TalkTalk |
|---|---|---|---|
| 2015 prospective yield | 5.1% | 2.8% | 3.9% |
| 2016 prospective yield | 5.2% | 3.2% | 4.6% |
Vodafone and TalkTalk offer the highest yields, but both companies currently pay dividends that are not covered by earnings. This is sustainable for a few years, but not indefinitely.
Is BT any different? The short answer is yes — BT’s dividend has been twice covered by earnings over the last few years, and this level of cover is expected to be maintained.
2. Profitability
Vodafone and TalkTalk’s’ lack of dividend cover brings us to earnings growth. This is a key requirement for telecoms firms, due to the ongoing high levels of expenditure needed to maintain and improve their services.
As you can see, earnings growth can be poor, even over quite long periods:
| Â | Vodafone | BT Group | TalkTalk |
|---|---|---|---|
| 5-yr earnings per share growth | -14% | +4.3% | -12.0% |
| 5-yr average operating margin | 6.4% | 13.4% | 4.9% |
BT is a clear winner here: it is the only firm to have grown adjusted earnings per share over the last five years, and it has a much higher operating margin.
3. Debt
Borrowing to fund investment and acquisitions is normal for big telecoms firms, but Vodafone’s $130bn sale of its interest in Verizon Wireless means that it has a significant advantage over the other two firms when it comes to debt:
| Â | Vodafone | BT Group | TalkTalk |
|---|---|---|---|
| Net gearing | 31% | 116%*Â | 195% |
| Interest cover | -3.2 | 6.1 | 3.6 |
* exc. pension deficit
Vodafone’s operating loss last year means that its interest cover is negative, whereas operating profits at BT and TalkTalk provide generous interest cover.
However, BT also has a £7.9bn pension deficit to deal with: this requires considerable extra cash each year, reducing the amount of free cash flow available for dividends.
Today’s best buy?
My pick of these three firms would be Vodafone. The mobile operator’s strong finance and global footprint are attractive, and I expect Vodafone to use its financial firepower to make one or more significant acquisitions over the next two years, which should help address the current earnings shortfall.
Indeed, I believe TalkTalk could be a potential acquisition target for Vodafone in the UK, as the smaller firm could give Vodafone much-needed exposure to the fixed line broadband and television markets.