The
telecommunication
sector
in
Europe
remains
challenging
for
companies
and
investors.
Cost
pressures
and
stretched
dividends
are
key
concerns.
Still,
pressure
on
the
industry
should
start
to
ease
as
inflation
cools.
While
the
wider
sector
is
undervalued,
share
prices
shouldn’t
be
investors’
only
considerations.
We
recommend
they
select
firms
with
prudent
dividend
policies,
good
capital
allocation
and
a
cost-conscious
mentality.
Key
Telecom
Stock
Picks
• Deutsche Telekom (DTE)
• Tele2 (TEL2 B)
Telecom
Stocks
Are
Undervalued
Telecommunications
conglomerates
such
as
Vodafone
and
Deutsche
Telekom
are
trading
at
around
0.85
times
price/fair
value
compared
with
streamlined
firms
such
as
Tele2
and
BT.A,
which
are
fairly
valued
at
0.97.
Historically,
conglomerates
have
more
complicated
corporate
structures
and
lower
cash
flow
visibility
due
to
different
market
dynamics
in
each
country
and
currency
fluctuations.
Investors
in
conglomerates
can
get
a
higher
return
on
investment
but
must
be
aware
of
these
pitfalls.
At
similar
valuations,
we
tend
to
prefer
streamlined
firms
due
to
their
more
straightforward
narratives
and
better
cash
flow
visibility.
Among
conglomerates,
Deutsche
Telekom
remains
our
favorite
given
80%
of
revenue
comes
from
US
and
Germany,
two
rational
markets.
Key
Telecoms
Industry
Issues:
•
Pricing
power
remains
low
(apart
from
in
the
UK)
•
Falling
inflation
will
lower
costs
and
increase
margins
•
Some
dividends
look
vulnerable,
such
as
Vodafone
and
Proximus
Only
in
select
markets
can
price
hikes
be
effective,
as
competitive
environments
often
neutralise
or
reverse
the
benefits
by
driving
customers
to
cheaper
providers.
In
contrast,
UK
firms
have
managed
to
pass
through
inflation
costs
with
minimal
churn
due
to
industrywide
actions.
However,
in
highly
competitive
markets
like
Italy
and
Spain,
price
increases
are
less
effective.
With
inflation
cooling
down,
we
see
cost
cuts
as
the
most
effective
way
to
recover
margins.
With
EU
inflation
dropping
to
2.5%
in
June
2024,
telecom
firms
can
expect
their
costs
to
fall.
Many
telecom
firms
keep
absolute
dividend
policies
despite
deteriorating
fundamentals,
and
they
pose
increased
dividend
risk.
These
firms
maintain
fixed
dividend
payments
rather
than
payout
ratio
policies,
often
leading
to
unmaintainable
dividends.
This
trend
highlights
the
peril
of
firms
delaying
necessary
dividend
cuts
until
the
last
minute.
Top
Stock
Picks
in
the
Telecommunications
Sector
Deutsche
Telekom
•
Morningstar
Rating:
★★★
•
Fair
Value
Estimate:
€25
•
Morningstar
Economic
Moat:
Narrow
•
Forward
Dividend
Yield:
3.25%
Narrow-moat
Deutsche
Telekom
offers
investors
exposure
to
two
rational
telecommunication
markets,
US,
and
Germany,
and
to
a
management
team
with
an
Exceptional
Capital
Allocation
Rating.
Deutsche
Telekom
shows
the
financial
discipline
and
operational
knowledge
required
to
generate
excess
returns
in
the
competitive
telecom
industry.
In
the
US,
Deutsche
Telekom
has
executed
a
brilliant
M&A
strategy
over
the
years,
acquiring
MetroPCS
and
Sprint
and
realizing
ambitious
cost
synergies.
Since
its
merger
with
Sprint
in
2020,
DT
has
steadily
been
gaining
share
from
Verizon
and
AT&T.
In
Germany,
Deutsche
Telekom
leverages
its
better
networks
and
knowledge
of
the
market
and
executes
gradual
price
increases
that
result
in
steady
revenue
and
EBITDA
growth.
Investors
in
DTE
can
expect
good
organic
execution,
with
growing
shareholder
distributions
in
the
form
of
buybacks
and
dividends.
Since
2019,
DTE’s
dividend
has
grown
from
EUR
0.60
per
share
to
EUR
0.77,
and
we
see
room
for
mid-single-digit
dividend
increases.
Tele2
•
Morningstar
Rating:
★★★
•
Fair
Value
Estimate:
SEK
100
•
Morningstar
Economic
Moat:
Narrow
•
Forward
Dividend
Yield:
6.47%
Investors
in
Tele2
can
expect
nicely
growing
dividends
going
forward
thanks
to
good
management
execution,
a
cost-conscious
mentality,
and
exposure
to
stable
or
growing
markets.
In
the
past
decade,
dividends
have
grown
at
a
4.5%
CAGR.
We
give
Tele2
an
exceptional
Capital
Allocation
Rating.
We
expect
revenue
will
grow
at
low
single
digits
and
EBITDA
at
mid-single
digits
thanks
to
cost
controls
in
coming
years.
In
Sweden
(80%
of
revenue)
Tele2
outperforms
Telia,
stealing
market
share
in
both
mobile
and
fixed
thanks
to
more
moderate
prices.
Tele2
has
a
cost-conscious
mentality,
paramount
in
the
telecommunications
industry,
having
reduced
operating
expenses
meaningfully
in
the
past
decade.
Some
20%
of
revenue
comes
from
the
Baltics,
where
Tele2
can
keep
growing
at
mid
to
high
single
digits
in
coming
years.
Tele2
properly
understands
that
telecommunication
companies
tend
to
have
stronger
positions
in
their
home
market
and
weaker
positions
abroad,
so
it
has
narrowed
its
business,
selling
most
operations
abroad.
This
article
is
an
edited
version
of
the
Telecoms
Europe:
Q2
2024
industry
report
published
on
Morningstar
Direct
and
written
by
Javier
Correonero
and
Ben
Slupecki.
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