Is this Telstra Store Operator Trading at Bargain Levels?

Telstra shares

Telstra Corp [ASX:TLS] isn’t the most loved stock this year. After a capital allocation review, Telstra decided to drop their payout ratio from close to 100% to between 70–90% of underlying earnings.

Not only did the beloved dividend payer cut dividends, their plans to securitise a portion of their NBN receipts had fell through.

Australia’s biggest telco is down more than 28% this year, as bargain buyers circle the beaten down Bluechip.

If you’re unsure whether you should jump into Telstra, why not look at Vita Group Ltd [ASX:VTG].

Vita owns and operates various telecommunication stores, such as Telstra, Fone Zone and One Zero. Unlike Telstra, Vita has had phenomenal growth over the past few years.

Revenues have grown by an average of 11.9% from 2014–17. Profits are up from $6.2 million in 2013 to $38.9 million in 2017.

What’s more, the company produces a ton of cash. Cash flow from operations are at least $10 million more than profits. It also costs very little to maintain and run their telecommunications stores, which allows Vita to generate $40–45 million in free cash flow.

Why has the Vita Group Stock Dropped?

Vita is down more than 50% in 2017. Much of their drop comes from restrictions from Telstra themselves.

On 11 May 2017, Vita announced changes to their remuneration structure with Australia’s largest telco. ‘The remuneration reductions agreed to between December and February were part of a response to margin pressures faced by Telstra in a very competitive mobility market,’ Vita said.

Those conditions continue to impact Telstra and the market generally, as we head into FY18 and beyond and have the potential to impact remuneration in the future. Consequently, Vita is working closely and confidentially with Telstra on remuneration and other commercial terms to find mutually acceptable ways of dealing with the challenges that lie ahead. Until these decisions are concluded, Vita has suspended any plans to expand the number of stores in its network.

Think of it this way. If Telstra doesn’t turn their performance around, they’ll likely reduce their remuneration agreement with Vita and reduce the roll out of more stores. Thus, for Vita, growth is stunted for as long as Telstra feels the need to.

But is the company really worth only $238 million?

Investors have already acknowledged that they may have oversold the stock. From its low in May, Vita is up 74.4%.

But is there more growth to come?

If we assume that revenues and cash flows decrease for the next five years and grow thereafter, Vita would still be an attractive investment to hold over the long run.

Of course there’s always the possibility an unforeseen event could push Vita’s share price lower. But with the information at hand, Vita looks like a stock which is still over sold by investors with a short term mentality.

Regards,

Härje Ronngard,

Junior Analyst, Money Morning

Harje Ronngard

Harje Ronngard

With an academic background in finance and investments, Harje knows how simple, yet difficult investing can be. He has worked with a range of assets classes, from futures to equities. But he’s found his niche in equity valuation.

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