Small Caps | Mar 20 2017
-Positive operating earnings and net profit expected in second half
-Extensive and growing network coverage in Australia, Singapore and Hong Kong
-Operating leverage is high, incremental costs minimal
By Eva Brocklehurst
Telecommunications infrastructure company, Superloop ((SLC)), is in the process of monetising its assets. Sales teams have been increased across the region and a new initiative in Hong Kong, initially targeting on-net customers, marks a milestone to accelerate growth in that market.
Brokers believe the company offers a highly scalable investment opportunity with the tailwinds that are evident in the industry. The Singaporean network went live in the September quarter 2015 and reached an operating profit in under 18 months.
The focus is on driving sales growth and establishing master service agreements with large enterprises now the network has been built. Once established, brokers believe the company will need to work to maintain its short-term market share gains, as the larger groups invest in their own networks.
The company is expected to become positive in terms of operating earnings (EBITDA) and net profit in the second half. Morgans expects capital expenditure will continue to expand but not to the same extent as over the last two years.
Morgans values the stock on a discounted cash flow basis with a 10% weighted average cost of capital. The stock trades at a premium to telecommunications peers and, in order to justify this, Morgans believes it also needs to grow at a faster rate than peers.
On current forecasts this will occur, but the broker is mindful the company first needs to successfully execute on its sales strategy. The broker retains a Hold rating for the present and a $2.74 target, acknowledging risks are now to the upside, with Superloop's extensive and growing network coverage and an additional sales push.
Canaccord Genuity agrees, noting that while Superloop is more expensive than its listed telco peers, the stock is cheaper than data centre comparables and trades roughly in line with ASX-listed infrastructure companies. The broker, not one of the eight monitored daily on the FNArena database, has initiated coverage with a Buy rating and $3.00 target.
Canaccord Genuity acknowledges the high level of operating leverage, as following the initial investment, the incremental cost of adding customers and driving utilisation is minimal, with revenue dropping virtually straight to the EBITDA line. The broker expects margins to expand to 30.8% in FY20 from 14.9% in FY17, which helps drive growth forecasts for earnings per share of around a compound 48%.
Even when charging 30-40% below market levels in order to gain share, operating leverage is still high and the broker expects gross margins to trend towards 85% in the short to medium term. Canaccord Genuity notes the incumbent telecommunications companies have been reluctant to meet lower pricing from alternative players.
The company now has network coverage in Australia, Singapore and Hong Kong, with a unique value proposition as the only owner/operator of telecommunications and digital services across these three jurisdictions.
The first half was largely about completing the build up of the Hong Kong network, which should be completed this month and the second half is expected to be a key sales period.
The regional network is reaching scale in Singapore, with over 30 key buildings providing access to over 1000 enterprises, and the company's early mover advantage is well recognised by brokers, as proactive fibre upgrades by incumbents have been slow.
Superloop has been rolling out its managed services and cloud business in the Asia-Pacific over the last three years. Last year it acquired BigAir Group, merging its connectivity with that company's last mile solutions.
A deal with Vocus Communications ((VOC)), will allow international, inter-capital and regional ethernet access and metropolitan fibre capacity in Australia. Earnings per share forecasts for the outer years are lower, Morgans warns,with increased depreciation estimates for both the BigAir and Vocus deal
The broker believes the company's recent agreement with Vocus has potential to meaningfully increase the synergies on the BigAir acquisition, where a large part of the cost base relates to paying third-parties for the telco access.
The company's ability to lower third-party carrier costs appears likely to surprise on the upside, in the broker's opinion, although confirmation is needed to better understand the upside risk. The main risk/reward relates to customer demand and the impact on the rate of organic sales growth.
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