Monday, November 29, 1999

ANALYSIS - European telecoms set for more falls as capex weighs

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European telecom stocks, which have fallen away badly this year, are set for further losses as they face the threat of rising capital expenditure, stricter regulation and slow economic growth.Analysts said the lure of traditionally high free cash flows and dividends is unlikely to be sustainable, and are uneasy about the lack of visibility on investments needed to improve and expand networks. Delaying investments, on the other hand, could cost companies customer confidence.The Stoxx 600 Telecom index is down 4.8 percent this year following a 12.1 percent gain in 2009 and analysts said the sector is set to fall further.According to StarMine data, 12-month forward earnings growth for the telecommunications sector is one of the lowest at 2 percent, compared to the DJ STOXX 600 average of 30.1 percent.For a graphic showing sales growth, click on:, although they are relatively high, have come down from a peak in April 2009, according to Thomson Reuters data.A number of telecom companies have changed the way they pay dividends from a pay out policy which connects it to the cash flow to a dividend policy which commits the company to paying shareholders a certain value over period and is more stable.Deutsche Telekom , KPN , Telefonica and Portugal Telecom , for example, hope to keep shareholders on board with promises of predictable dividends.For a graphic on dividend yields, click on: INVESTMENTS?Companies in the fixed-line business which need to invest in fibre networks in order to make their Internet services more competitive could see their cash flows come under pressure.On the wireless side, companies may find their networks unable to cope with the explosion of data traffic due to the adoption of mobile devices such as Apple's iPhone and be forced into higher levels of spending.While investors recognise the need for investment, they fret about the lack of transparency in company plans."Investors could be surprised by capex plans over the coming years and for a sector still generally mistrusted to allocate capital optimally, this is likely to lead to volatility in the shares," said James Gautrey, telecommunications analyst at Schroders."Until I see more concrete evidence that the companies will generate a decent return from their fibre/mobile investments, there are better opportunities elsewhere," he said.France Telecom's first-quarter results were hit by intense competition in France's fixed phone and broadband market, while KPN was left without access to the popular 800 MHz band in the crowded German market."A key concern for investors is the level of investments and the cash outlay needed to manage data growth," said ESN sector coordinator Andrea Devita at Banca Akros Italy.Brokerage ESN said it sees limited growth potential and modest earnings growth expectations in the telecom sector.But MFC Global Investments said Vodafone could be a winner and other analysts have cited its focus on network quality as beneficial for the stock.In the UK for example, Vodafone has been marketing its use of femtocells -- small in-house base stations about the size of a book that convert landline signals into mini mobile networks -- which take pressure off the main wireless network and are cheaper to install than new mobile base stations.It recently also won the highest amount of new radio frequencies at a German auction and won 3G mobile spectrum in an Indian auction."Some companies could see some revenue growth that the market clearly isn't pricing in at current levels and this would clearly underpin valuations and importantly dividend payments," said David Hussey, head of Pan European Equities at MFC Global Investment Management (Europe).REGULATORY RISKAnalysts have also said that telecoms profit margins could be hit by government reduction of mobile termination rates which means less revenue for companies.Regulators set the rates operators can charge each other to connect calls and cuts are likely to reduce European mobile operators' service revenue growth by 2-3 percent annually over the next three to four years, according to estimates by Fitch."The sector has some troubling secular issues which are weighing on institutional investor sentiment. Mobile in particular has seen margins diminish as regulation has had more and more impact," said Michael Kovacocy, analyst at Daiwa.In addition, austerity measures in countries at the periphery of the euro zone are likely to cause growth to slow and companies will be faced with higher funding costs if interest rates go up.Analysts said Portugal Telecom could be hit by government spending cuts.Greek telecom group OTE, which is 30-percent owned by Deutsche Telekom and has contributed large chunks of revenue to the German group, is reeling from the impact of its government's austerity measures, slashing its dividend as it struggles with a 76-percent drop in first-quarter profits.(Graphics by Scott Barber, Editing by Sitaraman Shankar)

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