- Year-to-date, developed European markets lead telecommunications inflows
- An unloved sector is staging a tentative comeback
- Focus on improving cash flow and operator pricing power
- The potential rise in mergers and acquisitions is seen as a tailwind for the sector
MILAN/LONDON, May 26 (Reuters) – Investors poured money back into unloved European telecoms stocks, expecting expensive investments to peak and a resurgence in mergers and acquisitions could lead to better yields.
The return of inflows could signal a turning point for a sector that last February recorded its worst underperformance relative to the market in more than three decades.
The high level of debt in telecoms is a factor that discourages many fund managers. But growing cash flow and a potential easing of the European Union’s historically tough stance on mergers in the sector mean the outlook for these stocks looks brighter.
“Some of the historic headwinds are fading,” said Luca Finà, head of equities at Generali Insurance Asset Management, which is now selectively overweight in telecoms, after being underweight in 2021 and neutral last year. .
“The investment cycle is largely behind us, leading to improved free cash flow generation, inflation leading to higher prices and (there is) an apparent more favorable stance from regulators on the consolidation,” he added.
So far in 2023, telecom sector funds have seen net inflows of $1.8 billion, recouping more than 80% of last year’s outflows, according to data from fund tracker EPFR.
Finland, Italy, Norway, Austria, Germany and France rank among the top 10 countries for the largest increases in telecommunications inflows this year.
Since February’s record low against the broader market, the sector has begun to rally and the STOXX Telecoms Index (.SXKP) is up 11% year-to-date, after rising 17 %. This compares to a peak gain of 10.7% for the region-wide STOXX Europe 600 (.STOXX).
M&A TESTING AND PRIKING POWER
Investors are also eagerly awaiting whether the European Commission will approve the €18.6 billion ($20.47 billion) merger between Orange (ORAN.PA) and Spain’s MasMovil. The decision, expected in September, is seen as a test case that could even make skeptics rethink their negative view of the industry.
“We don’t see much value in the sector. The only opportunity would be market consolidation,” said Ludovic Labal, portfolio manager of Eric Sturdza Investments’ Strategic Europe Quality Fund.
His fund does not invest in telecoms due to concerns about high leverage and slow growth.
Others are already becoming more positive, including the equity research team at Amundi, Europe’s largest asset manager, which has been recommending an overweight allocation since the second half of 2022.
Luca Corona, senior telecoms analyst at Amundi, said price increases for telecoms services do not appear to have been followed by smaller players who have used the opportunity to undermine their bigger rivals, as has been the case. cases in the past.
He also noted that France and Italy are two other markets that would both benefit from consolidation.
At an enterprise value of 5.8 times core earnings, European telecom is trading at a 21% discount to its 30-year average valuation, according to Refinitiv Datastream. Relative to the market, they are trading at a 31% discount on the same metric.
Telecommunications is a highly fragmented industry, with four players competing in many national markets. Price wars have squeezed margins over the years, just as fixed and mobile networks have required huge investments to meet growing data demand.
But the investment cycle is turning. The French Orange has achieved more than 90% of its fiber deployment and reduced its capital expenditure. Spain’s Telefonica (TEF.MC) and Norway’s Telenor (TEL.OL) said they were past or near peak investment.
This supports margins, as well as the price increases put in place in the face of soaring inflation, which could help gradually change the pessimistic discourse.
“The sector is no longer seen as a ‘no pricing power’,” said Olivier Baduel, director of European equity management at Ofi Invest Asset Management.
Also on the horizon is a potential boon from a European Commission consultation, launched in February, on who should foot the bill for billions of euros in investment in Europe’s telecommunications network. Operators have been pushing for decades for major tech companies to help roll out 5G and broadband.
UBS analyst Polo Tang estimates that this could raise up to 4 billion euros or ease the pressure on investments by optimizing network traffic.
($1 = 0.9084 euros)
Reporting by Danilo Masoni in Milan and Lucy Raitano in London; Editing by Sharon Singleton
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