Why You Should Be Avoiding Telcos

Sometimes, it’s the things you don’t do that make all the difference.

Let me explain…

One of the most tempting things for a novice investor is to buy into a former high-flyer after a decent share price fall. The fact that it’s fallen means it’s cheap, right?

Occasionally, that is the case. If you’re lucky. But, mostly, it’s not.

Mostly, it can get you into a world of trouble.

Take Vocus Communications [ASX:VOC], the fast-growing telecommunications company. As you can see in the chart below, from a low of around $1.55 in November 2012, the stock reached a peak of $9.50 in May this year. That’s a return of more than 500%.


Source: Optuma

It then started to correct lower. Which is nothing out of the ordinary after such a strong run. No doubt, some investors were tempted to ‘buy the dip’ here.

However, the first alarm bell sounded when VOC released its full-year results on 23 August.

The market’s response was not great, as you can see in the chart below. The selling continued in the following days. Something wasn’t quite right…


Source: Optuma

A month later, the CFO resigned. Some board members then resigned, and there was a stoush over who should run the business.

Once again, it may have been tempting for ‘bargain hunters’ to step in and buy among the uncertainty.

But it would have been a bad move. Recently, VOC had its annual general meeting, which it used to downgrade FY17 profit expectations.

The share price plunged nearly 25% as a result. The chart below shows the damage.dr20161215_image3

Source: Optuma

The golden rule

One of the golden rules that I apply in my premium investment service, Crisis & Opportunity, is that we never buy into a stock that is in a downtrend. You simply don’t know when the downtrend will end.

Needless to say, even after such a fall, I still wouldn’t go anywhere near VOC. Since peaking at $9.50 earlier this year, the share price has halved. You could make money on it by betting on a bounce, but that is a low-probability play. You’re much better off letting the dust settle and waiting for the trend to stabilise and then turn back up.

By the look of the chart above, that moment is still some way off.

As I said at the start, the stocks you don’t buy in this game are just as important as the ones you do buy.

I used VOC because it’s a recent and reasonably well-known story. But the message is the same for a multitude of stocks: Don’t buy into downtrends, no matter what you think or ‘know’ about a stock.

Avoid telcos

VOC isn’t the only potential value trap in the telecommunications sector.

Firstly, here’s the list of stocks that are making new lows:

TPG Telecom [ASX:TPM] — Near two years lows

Vocus Communication [ASX:VOC] — At two and a half year lows

Telstra [ASX:TLS] — Recently bounced from three and a half year lows

MNF Group Limited [ASX:MNF] — Two and a half month lows

Speedcast International [ASX:SDA] — One and a half year low

Superloop [ASX:SLC] — Three month low

Next DC [ASX:NXT] — Eight month low

This tells you there is something wrong with the profit prospects for the sector.

That something is the NBN.

The NBN is a government built monopoly. It consists of telecommunications infrastructure made up of a number of different technologies.

The private sector’s role (Telstra, TPG etc) is to hook their customers up to the NBN when requested. They pay an access fee to do so, and pass this on to their customers, as well as a retail margin to make a profit.

It sounds simple. But it poses a problem for the sector’s future profitability.

Here’s the problem…

As the NBN rollout continues, more people are signing up to the network. The margins the telcos make on NBN services are much less than what they make on standard broadband services.

The problem is that access charges to use the NBN network are too high. And that’s because the cost of the NBN rollout has been massive. By the time it is finished (apparently around 2020, but don’t hold your breath) the capital cost will be in the vicinity of $60 billion.

The high access charges are an attempt to get a return on this expenditure.

But it won’t work, because high costs will impede the take-up of the NBN. In addition, the telcos will build their own infrastructure where they can to circumvent the NBN charges, and new wireless technology (5G) is not far away.

This means that there won’t be anywhere near the eight million households hooked up to the NBN that the government expects.

It’s an all-round debacle. Quite possibly the NBN will go down as the most expensive white elephant in Australia’s history.

In the short term this is creating a bunch of headwinds for telco stocks. Take-up of NBN services is still growing strongly, as it’s in its early stages. With each household that switches from an old broadband service to the NBN, the retail margin falls dramatically.

With the recent profit announcements by TPG and VOC, this headwind has become apparent. Hence the recent sell-off in the sector.

But it’s also created uncertainty around the regulatory environment moving forward.

The way that NBN pricing is structured right now is unsustainable. It’s also reducing competition, as smaller players are unable to compete.

The Australian Competition and Consumer Commission are due to release a report on the state of the market early next year, as they know the current structure, if left alone, won’t produce competition.

On top of all this, there have been calls for the government to write off a large part of the NBN investment. Doing this will enable it to lower its access charges and still earn a decent rate of return on the lowered capital value of the project.

This is the most sensible outcome. But given politicians are involved, I don’t expect it to happen anytime soon.

Putting all this together, the industry is in a state of flux. That’s why you’re seeing share prices of the major players hitting new lows. The growth premium is coming out of the sector, and increasing uncertainty is being priced in.

In the short term, this means you should avoid the sector.

But I expect, during 2017, that there will be some fantastic opportunities to take advantage of. I’ll be following those opportunities for readers of my premium service, Crisis & Opportunity.

There are some great companies in the sector. It’s just a matter of working out which ones are able to best take advantage of the tremendous growth opportunities, while avoiding the regulatory issues that come with the NBN.


Greg Canavan
Editor, Markets and Money

Greg Canavan is a Contributing Editor at Markets & Money and Head of Research at Port Phillip Publishing. He advocates a counter-intuitive investment philosophy based on the old adage that ‘ignorance is bliss’. Greg says that investing in the ‘Information Age’ means you now have all the information you need. But is it really useful? Much of it is noise, and serves to confuse rather than inform investors. And, through the process of confirmation bias, you tend to sift the information that you agree with. As a result, you reinforce your biases. This gives you the impression that you know what is going on. But really, you don’t know. No one does. The world is far too complex to understand. When you accept this, your newfound ignorance becomes a formidable investment weapon. That’s because you’re not a slave to your emotions and biases. Greg puts this philosophy into action as the Editor of Crisis & Opportunity. He sees opportunities in crises. To find the opportunities, he uses a process called the ‘Fusion Method’, which combines charting analysis with more conventional valuation analysis. Charting is important because it contains no opinions or emotions. Combine that with traditional stock analysis, and you have a robust stock selection strategy. With Greg’s help, you can implement a long-term wealth-building strategy into your financial planning, be better prepared for the financial challenges ahead, and stop making the same mistakes that most private investors do every time they buy a stock. To find out more about Greg’s investing style and his financial worldview, take out a free subscription to Markets & Money here. And to discover more about Greg’s ‘ignorance is bliss’ investment strategy and the Fusion Method of investing, take out a 30-day trial to his value investing service Crisis & Opportunity here. Official websites and financial e-letters Greg writes for:

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