We’re often talking about what stocks we think you should look out for. But Morningstar’s latest European Telecoms Landscape outlines a sector you could consider skipping out on – and why.
“European communications have offered flattish returns since the peak of the dotcom bubble of the year 2000. European telecoms are a no-growth market, and they lack scale compared to their international counterparts. Pan-European operators can achieve little cross-border synergies, and the overall regulatory environment is harsh. We think investors should tread carefully and be considerate before investing in this sector, focusing only on the best operators and prioritising healthier markets”, said Javier Correonero, equity analyst at Morningstar.
The European Telecoms space is an industry battling with constant regulatory challenges and an excess of competition. In fact, European telecoms firms lag their international peers on both scale and pricing.
The sector faces a number of challenges, including:
Regulation is holding the sector back. European firms must comply with too many layers of regulation, including European, national, and sector-specific regulations. Pan-European telecoms like Telefonica, Orange, and Vodafone have realised little cross-border efficiencies for two decades given networks can be at different stages of developments across countries, and separate spectrum auctions. The regulatory landscape would need to be turned upside down to offer a more compelling framework that favours shareholder value creation.
Network overbuild has eroded efficient scale. There is too much redundant infrastructure in Europe. Rather than reaping the benefits and cost savings of sharing mobile infrastructure, European operators have for years built duplicated infrastructure, which results in higher cost and operational complexity. On the broadband front, network overbuild hurts the internal rates of return of new fiber projects. The durability of returns is also fragile: it only takes a new low-cost player to enter a market and start competing on price, and returns on invested capital will reset to a lower permanent base.
National governments are normally telecom firms’ largest shareholders. This can prevent cost efficiencies as it does not look good for governments’ political parties’ ambitions.
Agnostic of valuation, our top picks are Deutsche Telekom, KPN, Tele2 and Telenor, as they are the best managed companies in the sector. After a strong rally year-to-date the sector is mostly fairly valued, with only Vodafone and Liberty Global remaining in four-star territory.
The bottom-line: be picky and try to go for the best operators.
To access the report, click here.
