Top 4 ASX telecom stocks: the coronavirus impact examined

A flight to defence?

Some of Australia’s top telecommunications stocks have held up remarkably well in the face of the growing economic, social and health uncertainty entailed by the coronavirus (Covid-19) crisis.

In saying that, though telecom stocks may boast more defensive qualities than those in other sectors, as the below table illustrates – the inherent risk of equities should not be understated – with some of the ASX’s top telco stocks coming under strong selling pressure in the last month.

Even when considering those price declines, a recent piece of market research put forward by the investment bank JP Morgan argues that due to the essential nature of telecommunications services, the sector 'will be the last expenditure that at-risk households and SMBs cut from their spending, particularly as most of Australia likely goes into self-isolation and spends most of their time at home over the next few months.'

In terms of preference, Telstra Corporation is most favoured by JP Morgan, commanding an Overweight rating and a 12-month price target of $4.25 per share; NextDC is second on the list, with a Neutral rating and a price target of $8.25 per share; while TPG Telecom and Vocus Group are the least favoured of the pack – due in part to their exposure to a less premium customer base – both carrying Neutral ratings and price targets of $8.25 and $4.00 per share, respectively.

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Telstra, TPG, Vocus and NextDC share prices: the outlook amid the chaos

All up, Telstra remains JP Morgan’s preferred Australian telecommunications pick, due to its strong balance sheet, impressive cash generative ability and its premium customer base.

Centrally, one of the main reasons that Telstra remains so well positioned in this current environment is due to the high quality of its customer base. Specifically, JP Morgan notes that around a third of the telco’s revenues are derived from customers on the ‘premium end of the spectrum’, a fact that gives the investment bank faith that TLS’s revenues won’t ‘be affected much by the current environment.'

Finally, while the investment bank does note that Telstra has approximately $1.9 billion worth of dividend payments and $2.8 billion debt set to mature over the next year, the telco’s estimated free cash flow (which JP pegs at ~$5.0 billion) more than covers both of these commitments.

Secondly, NextDC, though moderately leveraged, is still well positioned to weather the next 12-months, according to JP Morgan. Overall, the investment bank doesn't see much risk to NextDC's revenues over the next 12-months, 'due to the contracted and recurring nature of its business, with customers consisting of enterprise, telecom, gov't and global IT companies.'

Thirdly, like Telstra, TPG Telecom's cash generative ability puts the telco in a strong position to weather the next 12-months of volatility; with a loan facility of $669 million also available should the telco need additional capital. However, unlike Telstra, JP Morgan notes that there is some 'earnings risk' here, given that TPG's customers are at the lower end of the premium spectrum.

Lastly, Vocus faces a similar issue to TPG – with approximately 25% to 30% of its earnings being derived from customers at the lower end of the premium spectrum.

Even though such customers pose an earnings risk, JP Morgan notes the other ~70% to ~75% of the telco’s profits provide some insulation, given that they are sourced from the government, enterprise and wholesale sectors.