Morningstar's "Perspectives" series features investment insights from third-party contributors. Here, Liontrust Asset Management’s Stephen Bailey asks: are telecoms the new equity income addiction sector?
As a manager of a thematic investment process which is built around identifying trends in social, economic and political spheres, it has been interesting for me to note the changing nature of consumer addictions. For any of you with teenage children, one of the most obvious addictions is to data – on mobile phones, tablets and computers. Could you imagine your children giving up their mobile phones for Lent, or switching to a ‘dumb phone’ of the type we had 20 years ago when a phone was a phone and not a mini tablet? For that matter, could you do without it?
For equity investors, this demand for data translates into a durable stream of revenues for the telecoms operators. While the defensive characteristics of telecoms shouldn’t be a surprise to anyone, we think the sector’s ability to generate recurring revenues and sustainable growth in dividends is still underappreciated at current share price valuations, which are generally at a discount to the market.
A number of UK and US telecoms groups have developed content-led quad-play offerings; fixed line, mobile, TV and broadband, which offer the prospect of defensive growth in sales, earnings and dividends as well as strong content-led customer loyalty. For this reason, we own BT, Vodafone, AT&T and Verizon within a Global Telecoms macro-theme.
We consider the investment credentials of tobacco to be gradually eroding, so investors would do well to consider telecoms the heir to the title of equity income addiction sector – the beneficiaries of dependence on mobile data consumption. To illustrate the contrast in prospects, consider that while British American Tobacco estimated an industry cigarette volume decline of 2.3% in 2015, Cisco reported that global mobile data traffic grew by 74% over the year.
This changing of the guard should be welcomed on ethical as well as investment grounds. Tobacco is unique in being one of the only businesses where sales growth is inversely correlated with the longevity of its customers.
Is Data the New Tobacco?
There is increasing evidence that this data reliance should indeed be treated as an addiction. Deloitte’s September 2015 Global Mobile Consumer Survey found that 44% of young people in the UK pick up their phone more than 50 times a day, with 55% doing so within 15 minutes of waking up. I have an 18 year old and 17 year old myself, and I can testify that these estimates may even be conservative.
Deloitte’s study defined its youngest category as 18yrs – 24yrs, so I think we can assume the figures would be even more compelling if the full teenage cohort were included.
The addiction appears just as strong on the other side of the Atlantic, with a survey by The Boston Consulting Group finding that almost a third of adult respondents would rather give up sex than their mobile phones. 46% said they would rather forego a day off work per week. The extent to which this dependence on mobile devices is emotional has been underlined by an Ericsson study which found a 38% heart rate increase in those watching badly buffered video content.
Without wanting to bombard you with statistics, I think it is also worth considering the manner in which this telecoms trend ties in with the housing affordability crisis which this country faces due to the difficulty in young people getting onto the property ladder. The ONS found that in 2013, the number of 20 - 34 year olds living with their parents had increased to 3.3 million – 26% of the age group, up from 21% when records began in 1996. As more households become family dwellings for longer, the demand for multi-faceted quad-play telecoms services – available in multiple rooms on numerous devices – should only increase. This not only suggests average revenue per user increases, but a stickier customer-provider relationship.
All the aforementioned trends reaffirm our belief in our Global Telecoms theme, which forms around 20% of our macro-thematic income strategy.
Defensive Growth is Hard to Find
The identification of a sector capable of providing defensive growth in earnings and dividends is all the more valuable given the relative scarcity of this combination in the UK market currently.
When we talk of defensive exposure, it is insulation from the cyclicality of economic and business cycles that we are referring to. But it seems that, in return for this non-cyclical exposure, investors must in many cases be willing to accept low/no growth such as utilities, or long-term sales decline such as tobacco. Alternatively, for a defensive sector capable of achieving moderate growth – such as consumer staples – investors must be willing to pay up for shares on stretched high-teens multiples, which obviously restricts the income yield that is achievable.
If income investors were instead to consider the more cyclical areas of the market, these are rife with dangerous yield traps.
We therefore think there is a strong case for rotation out of some of these traditional income sectors into the telecoms sector. Defensive sectors of the market have traditionally been priced at a p/e discount and yield premium to the market to compensate for a lack of growth dynamics; AT&T’s share price rating of 13.7x 2016 expected EPS and dividend yield of 5% suggests that this is still how much of the telecoms sector is seen.
But we think the sector’s growth potential will allow it to repeat the trick of the consumer staples sector such as Unilever, Reckitt Benckiser et al, a few years ago: shifting from a share price discount to a premium as its growth credentials gain greater investor understanding. We benefited from owning a number of these global consumer staples stocks between 2009 and 2013, when the sector was re-rated from ‘value’ to ‘growth’.
We think that telecoms could be the next sector to experience a similar transition. There are reasons to believe that the 70% plus annual growth in mobile global data consumption referred to earlier will be sustained rather than tail off. Cisco estimates that smart devices are only 36% of the total mobile device market globally, but they account for nearly 90% of mobile data traffic. In 2015, it estimates that a smart device generated 14 times more traffic than a non-smart device. As smart device penetration grows from its level of 36%, so too will data consumption – we therefore think that there is huge scope for future growth. Cisco estimates that around two-thirds of devices will be ‘smart’ by 2020.
While this trend provides a significant long-term driver for our Global Telecoms theme, short term support is also present in the form of the sector’s significant non-sterling exposure at a time when Brexit risks are weighing heavily on the pound.
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