One of the benefits of tracking industry ETFs is that it helps us answer the question : which industry is the weakest, which is the strongest and what will be our best bet ? Or better still within each industry which combination of stocks will produce the best value for money.
Telstra announced its results last week and it is worthwhile looking at the headwinds that are faced by US Telecoms businesses listed on North American exchanges.
Telecoms generate massive cash flows and equally large demands on capital investment and depreciation. This means that the actual return on equity remains low after the cost of depreciating expensive infrastructure assets. Yet the market price being paid for investment in Telecoms remains high. In terms of our ALTAR score ( our measure of overall investment merit ) US Telecoms (IYZ) are one of our least favoured industries.
US Telecoms ( all Telecom stocks in aggregate as measured in IYZ) operating cash flow exceed earnings by more than any other industry we follow because of the heavy cost involved in capex and depreciation .
Statistics on US Telecoms ( IYZ )
- Average return on Equity (5 yrs) 5.3%
- Price to Book Value 2.0 times
- ALTAR Score™ = 2.2% ( after all expenses)
Which means that based on earnings over a business cycle and paying today's prices an investment in US Telecoms (IYZ) generally will produce a return of about 2.2 per cent a year.
The current Price-to-Earnings ratio is 45 times and on forward earnings it is 25 times . But PE ratios are a poor measure of future value. The price paid for a return on equity is a far better measure of the return an investor will actually get for a dollar invested today.
It is worthwhile noting that the Price-to-Book Value for US Telecoms generally is about two times. In Telstra's case it is closer to three/four times . US Telecoms ( the aggregate value of all stocks in IYZ) yield on average about 3.7 per cent while Telstra's yield is more than three times greater at over nine pct.
US Telecoms (IYZ) remain a low margin, low return on equity business. Wireline and wireless require massive investment in its fiber optics businesses and a drain on the ability to pay dividends.
iShares Global Telecoms ( IXP ) Australian Listed
Outside the United States the picture is quite different dominated by stocks like Vodafone, Telefonica and China Mobile .
Calculation of ALTAR Score for IXP
- Avg. Return on Equity: 13.0%
- Divided by P/BV: ÷ 1.4x
- Less: expense ratio: - 48bp
- Equals: ALTAR Score: 8.2%
Valuation Metrics for IXP
| 2009 | 2010E | 2011E | |
| Price-to-sales | 1.2 | 1.2 | 1.1 |
| Price-to-earnings | 12.4 | 11.9 | 11.2 |
| Price-to-cash flow | 0 | 4.5 | 4.4 |
| Price-to-growth | 2 | 1.9 | 1.8 |
| Price-to-book value | 1.5 | 1.4 | 1.4 |
| Yield-gross | 5.30% | 5.70% | 5.90% |
As competition grows in Australia and margins are reduced towards US levels for Telecoms, even though cash flows are growing strongly, valuations cannot ignore the tidal influence ( reversion to the mean) of US valuations. ( Current Telstra consensus ROE is 30 pct and price to book is three times giving an equivalent ALTAR score of about ten per cent).
IXP represents an affordable alternative to a direct investment in just one telecom stock.
