Important information: The value of investments and the income from them, can go down as well as up, so you may get back less than you invest.
Technologies which promise to change the world will always excite stock pickers. Today, the hype surrounds US tech giants - think Microsoft, Apple, and so on. Others, spearheaded by Tesla, look to capitalise on new waves of consumer trends, ranging from renewable energies to AI to space exploration. Each believes that it will become the next big thing.
Go back 20 years, and it was telecommunications companies generating all the hype. During the late nineties and early noughties, the telecoms industry positioned itself as the backbone to the new economy of the internet and investors queued up to pile in.
What followed is what’s often referred to as the “dotcom bubble” - a massive rise in stock market valuations followed by a swift bursting of the bubble which saw most go bust. Even blue-chip tech companies like Cisco and Intel saw their value drop an eye-watering 80%.
Now, the sector looks much changed. Hardly the stock market darlings of yesteryear, telecoms have assumed a reputation for gobbling through cash, piling up huge levels of debt, and demonstrating poor operational performance.
Telecoms may be out of fashion, but this is a broad industry with different offerings to appeal to different investors. It’s a mistake to dismiss it out of hand. Well-known names have morphed into traditional sources of income, while a crop of smaller but impressive companies look to capitalise on mounting demand for ever stronger connectivity.
Been there, done that
Vodafone and BT have both seen their fair share of what the market has to offer. Both were among those to experience both the highs and lows of the 2000 bubble. Now, having enjoyed the revelries of youth, they’ve settled over time to dominate the UK telecoms sector.
However, neither has completely redeemed itself in the eyes of investors, with both facing particular difficulties over the past five years. Over that period, BT’s share price has fallen over 50%, Vodafone nearly 50%. Both have been plagued by limited growth opportunities while still investing huge amounts to upgrade and improve their networks. Like the proverbial duck paddling against strong currents, both companies are burning through cash just to keep afloat.
That’s seen BT accrue net debt of £17.3 billion, according to its latest annual results. It will concern shareholders who may be worried the company will be forced to dip into future dividend payments.
Dividends are a particularly sore topic for BT investors right now. For a while considered one of the strongest payers on the FTSE 100, the Coronavirus pandemic kicked BT’s 2020 payments into touch. The company has said it doesn’t intend to restart payments this calendar year.
On the flip side, and in stark contrast to what investors may recall from 2000, BT now looks very cheap, with a price of around 10 times earnings. Cheap is not the same as good value, but there are some signs of encouragement here.
BT has a near monopoly of the UK’s broadband infrastructure and owns the UK’s largest mobile network, EE. While it spends a lot of money, it makes a fair amount too. Total revenue for the year up to 31 March came in at £21 billion, with a pre-tax profit of £1.5 billion.
The question investors will want to ask themselves is whether the long-term profitability of the business looks attractive when offset by high levels of spending - the latter of which are only likely to rise in the short term as the company looks to manage its debt and expand its fibre broadband and 5G mobile networks.
Judging by more recent price rises - its share price has risen 72% over the last year - the market appears to see BT’s current price as a buying opportunity. But it doesn’t come without risks.
Unlike BT, Vodafone, the UK’s largest telecommunications stock by market cap, has maintained its place as one of the FTSE 100’s big dividend payers throughout the pandemic. A current yield of around 6% inspires both curiosity and concern.
In part it’s the result of a falling share price - down nearly 4% year-on-year - which has pushed the yield up relative to price. But don’t be too worried; the stock had been steadily rising through 2021 until the company released its annual figures in May, which revealed the extent to which Covid travel restrictions hit roaming revenues as well as falling handset sales.
A more pertinent question is how well that dividend is covered - here too there’s cause for concern. A dividend cover of 0.9 tells you the money it distributes exceeds earnings. Add on top of that Vodafone’s high level of debt and plans for growth and you may wonder where that cover is coming from. Nevertheless, the company kept its dividend payments up throughout 2020, despite the pandemic dampening revenues on roaming charges, and has made no suggestion of dropping payments in the future.
Perhaps more encouraging is the company’s potential to grow. Best known as a mobile operator in the UK, Vodafone has a greater international presence than BT, especially across Europe where it operates major broadband networks too. It also has a strong presence in Africa, as both a mobile network and a mobile payment system. Both areas could see meaningful growth over the medium term.
Party like it’s 1999?
BT and Vodafone have shed the volatile mantle investors associate with the late-nineties dotcom mania, and settled into the sort of income-paying FTSE staples our home market is renowned for. Investing in these companies depends on your outlook for their long-term viability in a fast-accelerating world versus their short-term debt obligations.
But that’s not all this sector has to offer. Look beyond those familiar names and there are some interesting growth opportunities to be found here too.
One of the UK telecoms industry’s worst-kept secrets is Gamma Communications. Gamma ties neatly into those areas of telecommunications where lie the greatest growth potential, offering instant messaging, video conferencing, cloud communications and other upward trends to businesses of all sizes. It’s actually one of the few UK stocks that offer investors direct access to the cloud computing market.
It’s been on a rampant upward trajectory in recent years. Earnings grew 86% over the past year, and are projected to grow a further 7.5% per year. Annual earnings per share have grown a remarkable 40% over the past three years. The company is expanding its presence on mainland Europe too in an effort to replicate its remarkable UK success abroad.
All this growth is bolstered by solid fundamentals. The company boasts a strong balance sheet, and even offers a regular dividend, though only at a small yield of 0.9%.
There are growth opportunities to be found elsewhere. Founded in 1936, Spirent Communications is hardly a high-octane start-up of the sort prevalent in 2000, but it is a potential beneficiary of the shift to 5G connectivity.
Spirent specialises in producing the 5G equipment used in telecommunications networks. The company laid out its plans to “maintain and grow our 5G leadership position, and capitalise on the accelerating opportunity” in its most recent set of annual results.
However, competition here is fierce and Spirent will have to keep its position at the front of the pack to maintain any meaningful market share. If it can do that, this certainly could prove a profitable venture for investors.
Of course, we’ve been here before. The dotcom bubble has left investors wary of telecoms companies which overpromised and underdelivered. But for savvy investors, whether they’re seeking value stalwarts or looking to capitalise on a wave of technological advancements, there’s good reason to keep an open mind.
Five year performance
(%) As at 23 July
Past performance is not a reliable indicator of future returns
Source: FE, total returns in GBP terms as at 23.7.21
Important information: Investors should note that the views expressed may no longer be current and may have already been acted upon. Reference to specific securities should not be construed as a recommendation to buy or sell these securities and is included for the purposes of illustration only. When you are thinking about investing in shares, it’s generally a good idea to consider holding them alongside other investments in a diversified portfolio of assets. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to a Fidelity adviser or an authorised financial adviser of your choice.
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