The telecoms industry seems well equipped to deal with the crisis. As turnover is primarily generated by innovations, the industry is fairly resistant to fluctuations in business. Therefore, investors who want to protect themselves could be interested in adding telecom companies shares to their portfolio.
This New Year’s Eve, a record-breaking 360 million SMS messages were sent in France. That was over 30 percent more SMS messages than the previous New Year’s Eve. The telecoms operators seem to be barely feeling the effects of the recession. In fact, over the last few months, telecoms shares have demonstrated a relatively strong resistance to the turbulent stock market. While the wider European market suffered a loss in value of almost 30 percent since October 2008, the European telecoms sector fell by a modest 10 percent. Clearly the telecoms industry is not completely immune to the effects of an economic downturn, however, the negative influences will have less of an impact on turnover and margin development than they will in many other sectors. We have come to this conclusion for the following reasons:
Turnover is driven by innovation
There are two main elements that influence turnover when it comes to telecoms companies: client growth and turnover per customer in cellular phone and fixed line/broadband/internet sectors. Both elements have continued to grow over the last 10 years despite economic cycles and despite the fact that they are influenced by sector-specific factors such as regulation, price development, competition and market penetration. We expect these sector-specific influences to remain prevalent in the future as there is currently no firm evidence to suggest that the effect of the recession on income is causing clients to change the way they use their phones or changing the dynamic of customer growth. In fact, turnover will be even more driven by innovations. The success of Apple’s new 3G iPhone shows that clients are prepared to pay more per month for these innovative products than ever before — regardless of the financial crisis and economic downturn. Turnover trends are therefore more likely to be driven by the anticipation and implementation of a technological innovation (broadband and mobile internet) than periods of economic downturn.
Margins are likely to remain fairly stable
One of the main concerns for investors is margin development, which pessimists believe will suffer during the financial crisis and economic downturn due to increasing financing costs for investments and rising operating costs. However, we believe that the cost structure of telecoms companies is more flexible than people think. For example, a decline in customer growth leads to a reduction in marketing and acquisition costs. Less money is spent on mobile phone subsidies, which frees up operating margins to some extent. Over the last two years, many companies have also implemented cost reduction programs which will really start to pay off in 2009. Future investments can be delayed without risking a negative impact on daily business. Last but by no means least, we must mention baseline effects that no longer have an impact on operating margins due to the declining effects of administered tariff reductions — this includes tariff reductions resulting from roaming or termination fees, for example. Companies, therefore, have a sufficient safety net to absorb losses in turnover and keep their margins stable.
Steady cash flow and sound balance sheets
The aforementioned factors indicate that telecoms companies can keep cash flow generated by their operations at a fairly steady level. Based on current estimates for turnover, margins and cash flow between 2008 and 2011, the return forecast remains fairly stable even though growth in turnover seems to be fairly sluggish for the sector as a whole. Taking into account the low level of debt typically accrued by the telecoms industry in the past, the risk of refinancing is relatively minor. On average, the earnings before interest and taxes (EBIT) generated by the European telecoms industry cover its current interest expense more than five times over. These attributes are a major attraction to investors during a recession, which suggests that the industry will continue to outperform the market. Careful investors should therefore incorporate telecoms shares into their portfolio during the 2009 investment year.
Uwe Neumann is an equity analyst at Credit Suisse
