- Why is European economic growth not the same as stock market opportunity?
- Have telecoms delivered for investors post the 2000 tech boom?
- What is the outlook for revenue growth and profits in the telecom sector?
European equity markets had a turbulent first quarter, falling 8%*. Additionally, volatility and uncertainty have increased, with risk re-priced as a result of growth rates being brought into question.
Pressure was exacerbated by the valuation compression of highly valued sectors like technology or pharmaceuticals, and anything with a strong cyclical or emerging market bias. In effect, investors have questioned the prospects for economic growth, and the effectiveness of policy tools to deliver solutions.
These fears have some justification, but in certain sectors the prospects for growth are improving. This is because economic growth is not necessarily the same as stock market opportunity. If we focus on what is changing, there is the basis for some optimism. The telecoms sector in Europe has exploded in terms of the services it has delivered over the last 15 years, as many of the dreams from the tech boom have been realised – fast access speeds for data, and ‘always on’ mobility for both the internet and voice access. There has been a clear increase in usage and functionality. However, the telecom companies supplying these services have typically not been a particularly rewarding investment over this period.
There are many reasons for the historic performance of the telecoms sector, but to illustrate the point we can focus on just a couple. Valuations started at too high a level and regulation championed the consumer and supported new market entrants, leading to a deflationary trend and a de-rating of share prices. This is now changing, regulation has shifted to stimulating network investment and capital expenditure has risen over 25% in recent years. Companies without networks are being squeezed and there is a new focus on delivering a return on investment.
All this is driving attempts at consolidation and we have already seen evidence of this in the UK, Germany, Belgium and Spain. Further material consolidation is also a prospect in Italy and France. We have also seen an easing of the precipitous decline in mobile service revenues, although this is not a guarantee of improved profits or earnings. Furthermore, broadband services and pay television delivered via fibre are going some way to offset the decline in fixed-line traffic.
Various new technologies are squeezing more performance from legacy copper networks, and new all internet protocol (IP) networks offer the prospect of cheaper operating costs once they are established. This offers the possibility of some modest revenue and profit growth from a newly established base as participants settle for a more stable market share. There are also fewer subsidies via incentives, such as handset sales, to stimulate demand. Therefore, moderate growth and an encouraging future for these companies create the potential for a stock market re-rating. If this is delivered, it makes current dividend yields upwards of 3.5% attractive against alternatives, including negative rates on cash and many bonds in much of Europe.
So despite the uncertainty, a disappointing earnings season and with some sectors still struggling, the telecoms sector has already seen substantial structural reform. These changes are driving better prospects both for the industry and as an investment opportunity. Through our bottom-up investment process, we remain confident that we will continue to find opportunities even if pockets of weakness across Europe persist. The telecoms sector is just one example of this.
*FTSE world Europe ex UK 31.12.15 to 31.3.16 in euro.