Treasure Chest | Jun 08 2021
This story features UNITI GROUP LIMITED, and other companies. For more info SHARE ANALYSIS: UWL
With a growth rate three times that of sector peers, Uniti Group is set to benefit from the scale afforded by recent acquisitions.
-Company considered to have infrastructure-like qualities
-Mandated regulation for greenfields to be fibre-ready
-Jarden expects double-digit earnings growth over the next five years
-Growth rate is three times that of sector peers
By Mark Woodruff
It has been the best of times for early shareholders in Uniti Group ((UWL)).
The company listed on the ASX at 25c in February 2019, with a stated strategy of becoming a leading provider of niche telecommunications services. The share price since that time is up over 12 times and has increased over 160% in the last seven months.
If a recent report from broker Jarden is anything to go by, there may still be material upside for the share price. It’s felt the effect of recent acquisitions is still undervalued as they transform the group into a competitive last-mile fibre operator. The broker arrives at a valuation 16% above the prevailing share price, even when excluding two of the three segments of the business.
The broker is positive on the company given strong industry drivers. Additionally, double-digit earnings growth is expected over the next five years, by executing on already contracted business.
Uniti Group has established its current position through a series of acquisitions in the first half of 2021. These include OptiComm, Harbour ISP and Telstra's ((TLS)) Velocity network assets. The group is now the number two provider behind the government-owned National Broadband Network (NBN). Smaller competitors include gigagfy, Fibre Corp, Lightening Broadband and Redtrain Networks though none have established a scale position.
The key reasons that developers partner with Uniti Group include lower pricing and the inclusion of TV and ‘smart-building’ services. Additional reasons are improved co-ordination with the developers and estate aesthetics.
Jarden’s investment thesis provides for a valuation 29% in excess of broker consensus.
What does the wholesale and infrastructure segment do?
Uniti's Wholesale and Infrastructure (W&I) segment accounts for around 84% of the broker’s estimated FY22 earnings. It’s anticipated this segment will generate margins of over 70% as activations grow.
W&I is the company’s core fibre infrastructure operation that competes with the NBN to provide fibre to greenfield houses and apartments. It represents a strong competitive alternative because current regulations require all new greenfield housing developments to be fibre-ready, explains Jarden.
The W&I division constructs fibre to the premises (FTTP) telecommunications networks capable of delivering super-fast broadband and a host of other services that may be carried on such networks. Revenues generated from this are one-off and project based.
In addition, there are recurring revenues derived from the wholesale sale of broadband and voice services on the FTTP networks to retail service providers (RSP’s). They on-sell those services to end-users, being residents and businesses in dwellings within the broadacre estates and multi dwelling unit complexes.
The W&I division also constructs and supplies integrated communication networks (ICN’s) and services that are carried over the FTTP networks. An ICN is an intelligent network capable of addressing all the communications needs within a large building or campus. These deliver a number of applications and outcomes useful in managing security, access, monitoring and communicating in environments often termed as smart buildings or communities.
Uniti’s two other business segments iare Consumer & Business, which provides broadband and voice services to retail end users, and Communication Platform as a Service (CPaaS), which provides value added software for call tracking and data analytics.
Jarden highlights that steady dwelling growth of around 200,000 fibre-ready-completions every year provides a growing addressable market.
The demand for quality-fixed-line fibre is also heightened by the anticipated increase in consumption of data and the need for greater bandwidth.
The group’s acquisition in last mile fibre in the past 18 months, alongside Telstra participating as a RSP for the Uniti Group network, positions the group as an even stronger competitor against the NBN. Jarden believes this could throw up opportunities to grow market share in greenfields.
As the group delivers and activates premises from its contracted pipeline, higher quality earnings and cash flows should result.
The broker’s three year forecast EPS compound annual growth rate (CAGR) of 19% is three times that of comparable telecommunications companies. The group trades at an around -30% discount on a price/earnings-to-growth (PEG) ratio to growth stocks. This ratio is a company's stock price to earnings ratio divided by the growth rate of its earnings for a specified time period.
Other potential kickers for the share price
Jarden sees potential ASX200 index inclusion and an update on its contracted premise pipeline as near-term catalysts.
New developer agreements and the potential for further M&A present upside opportunities, suggests Macquarie. M&A is relevant, given the recent transactions in the sector with acquirers including Aware Super, Macquarie Infrastructure and Real Assets (MIRA) and other domestic and international infrastructure investors.
Why the higher valuation by Jarden?
There is a significant valuation difference between Jarden and consensus. However, it doesn’t arise as a result of any material difference regarding forward EPS estimates. The distinguishing feature is that the broker utilises more infrastructure-like inputs for the W&I segment when generating a financial model. In broker-speak, this involves valuing the ‘explicit unlevered cash flows in W&I, assuming a weighted average cost of capital (WACC) more closely aligned to infrastructure assets”.
Consequently, Jarden derives a 12-month forward equity value for W&I alone of $3.48 per share, which is 16% above the prevailing share price (at the time of the broker report). The remaining two segments of the business are attributed a valuation of 41c, which lands us nicely on the overall 12 month target price of $3.89. Jarden rates the company a Buy.
Having ascertained the point of difference between Jarden and the consensus, it does beg a couple of other questions. Is an Infrastructure-like valuation deserved? and what further information may we glean from the other brokers compromising that consensus?
Is an Infrastructure-like valuation appropriate?
The group’s FTTP networks exhibit low price risk as prices are primarily dependent on the pricing of its primary competitor. At present, Jarden assesses the NBN will likely increase their wholesale average revenue per user (ARPU) metric. As a result, the estimated earnings margins for the W&I segment are in excess of 65%.
Also, on greenfield networks, FTTP operators effectively run monopolies with the key risk on future contract growth, explains the broker.
With the combination of low risk cash flow, effective monopolies and mandated regulation for greenfields to be fibre-ready, it is certainly looking like a quasi-infrastructure investment.
Other broker views
Macquarie believes the scale achieved via acquisitions has positioned the group to deliver organic growth. The Telstra Velocity network assets transaction in the first half of 2021 enables Uniti Group to include Telstra as an RSP. This is an important factor in the group continuing to grow contracted premises agreements with developers. The broker has an Outperform rating and a $3.36 twleve month target price.
Along similar lines, Goldman Sachs sees barriers to entry in this market, with developers requiring telco partners. The increased scale of Uniti makes it large enough to attract the majority of key RSPs, including Telstra, which enables larger developer contracts. For example, industry feedback suggests Stockland and Mirvac required Telstra service before partnering with Uniti Group.
The broker also highlights any capital deployed can earn very high returns given the potential to cherry-pick high returning developments and to earn upfront development contributions (to offset capex). A Buy rating and $3.00 target are set.
In an update in late May, 2021, Ord Minnett increased its twelve month target price to $2.90 from $2.23 and lowered the rating to Hold from Accumulate. The broker was buoyed by Australian Bureau of Statistics March quarter data showing new dwelling numbers experiencing another quarter of above trend growth. The broker considers this is supported by positive sales and pricing commentary from greenfield property developers in 2021.
At the time of the update, Uniti was trading at a 24% premium to its peer group. The broker supports a premium on the basis of the duopoly style private fibre market, stability in wholesale price linked with the NBN’s pricing policy and improving free cash flow returns.
The broker also felt integration risks with the recent OptiComm acquisition are reducing as we approach FY22.
In a late April 2021 update, Bell Potter maintained a Buy rating and increased the target price to $2.85 from $2.50. Despite competition in the market, the broker expects connected premises to double by 2026 and active premises to more than double by 2025.
In the wake of a strong interim result in March 2021, Canaccord Genuity maintained a Buy rating and lifted the target price to $2.60 from $2.40. The broker highlighted the group had then started to realise earnings from the cash-generative businesses acquired.
Jarden contemplates competition risk on tendering for greenfield developments. Additionally, there is development execution risk of already contracted premises.
Meanwhile, Macquarie cautions on integration risks for the several recent and material acquisitions.
It should also be noted that Uniti’s wholesale pricing is a declared service, with pricing caps regulated by the ACCC (which allows for cost recovery on investment). This creates some risk of any regulated change in the pricing model of the group, notes Goldman Sachs.
Also, in Australia, given the highly regulated access costs on fixed-networks, the broker expects all mobile network operators to accelerate 5G fixed wire access (FWA) offerings. Telstra recently estimated an extra 10-15% of households could become mobile-only over time. However, the broker notes Uniti Group has the potential to pull a number of levers to offset the impact of an increase in mobile-only households.
Jarden, Bell Potter, Canaccord Genuity and Goldman Sachs are not one of the seven stockbrokers monitored daily on the FNArena database.The database has one Outperform rating (Macquarie) rating and one Accumulate (Ord Minnett). The consensus target is $3.13, suggesting 0.3% upside to the last share price.
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