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Buy the Telecom Plus energy boost

The multiutility company is well placed to benefit from proposed price caps
October 19, 2017

The government’s move to clamp down on energy prices has caused concern for many of the mainstream electricity and gas providers. For Telecom Plus (TEP), however, the proposed price cap to standard variable tariffs is very good news. Granted, the multiutility group may have aligned itself to this cheap energy environment prematurely (a long-term deal to keep prices down was locked-in in 2013 and has since undercut by smaller peers taking advantage of low wholesale costs), but as the current market evolves its price positioning should be very competitive. 

IC TIP: Buy at 1195p
Tip style
Income
Risk rating
Medium
Timescale
Long Term
Bull points

 

Rising margins and falling churn
Favourable energy market trends
Strong balance sheet and cash flow
High-yielding dividend

Bear points

 

Slow forecast profit growth this year
High PE ratio

Telecom Plus bundles together gas, electricity, mobile, broadband, landline and home insurance contracts, to provide consumers with attractive tariffs. It is described as “a discount club” (by none other than Joanna Lumley on the website’s information video) and differentiates itself from the dominant utility providers by offering fair, consistent prices to both new and existing customers, the convenience of a single monthly bill and excellent customer service. The group operates via the Utility Warehouse brand and advertises using an “army” of 41,717 partners who get further discounts on their own bills by recruiting new customers.

However, this model has proved unhelpful during a recent period of cheap energy and viciously competitive telecoms contracts, and the group’s shares have plunged almost two-fifths from their 2013 highs as a result. But the tide is now turning. Regulatory changes in the energy market should make it easier for Telecom Plus to win more business. Moreover, the group sees energy customer churn – the number of customers switching to other suppliers – of about 13 per cent, significantly below the industry average.

Higher average telecoms rates and requests for quality customer service have led to an increased demand for the group’s telephony contracts. Management has focused on its high-margin mobile services, recently offering 4G for the first time and increasing the data allowance for double gold members. This helped send mobile contracts up 19 per cent to 201,375 in the year to March 2017. Overall, the group supplied a total of 2.3m services, up 5 per cent on the previous year. This growth rate is likely to accelerate thanks to the recent addition of home insurance services.

More importantly, half of new customers are now bundling together at least five of the group’s services. These ‘Double Gold’ members have very low churn, meaning the sales outlook is becoming far more certain. All-inclusive customers also helped spark a one percentage point uptick in gross margins to 17.6 per cent in the 2017 financial year. In the long term, a higher proportion of Double Gold customers should feed through to wider operating margins, too. However, the group’s promise to fit these customers’ homes with ultra-efficient LED lightbulbs means higher operational costs in the first year. That’s why brokers expect stagnant profit growth in the year to March 2018, before a pick-up.

The balance sheet is in good shape, partly thanks to £71m proceeds from the sale of the group’s 20 per cent stake in energy company Opus. Management returned £25m of this cash to investors by way of a share buyback after the 2017 financial year-end, meaning the group is now in a net debt position, but this remains less than one times adjusted cash profit. The decision to hold back some of the cash from the sale was taken with growth into new markets in mind. With net (after tax) operating cash inflows of £43m in 2017 and a strong balance sheet, Telecom Plus has plenty of firepower for future acquisitions, which brokers think could provide a higher rate of return for investors. 

Despite expectations of muted profit growth in the current financial year, the group has stated that it intends to raise its dividend to at least 50p, equivalent to a 4.3 per cent yield. Beyond that, management has guided to an 85 per cent payout ratio, which should mean decent income growth if the group starts winning new customers as expected. 

TELECOM PLUS (TEP)    
ORD PRICE:1,195pMARKET VALUE:£937m
TOUCH:1,193-1,197p12-MONTH HIGH:1,342p1,035p
FORWARD DIVIDEND YIELD:4.4%FORWARD PE RATIO:21
NET ASSET VALUE:329p**NET CASH:£18.7m
Year to 31 MarTurnover (£m)Pre-tax profit (£m)Earnings per share (p)Dividend per share (p)
201572945.945.040.0
201674548.849.546.0
201774053.253.048.0
2018*79253.353.850.0
2019*83256.957.852.0
% change+5+7+7+4
Normal market size:500   
Matched bargain trading    
Beta:0.78   
*Broker finnCap forecasts, adjusted PTP and EPS
**Includes intangible assets of £194m, or 249p a share