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Telco stock has bright future

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Hot stock: Vita Group (ASX:VTG)

Key statistics:

31/05/16 closing share price: $3.79 52 week high: $3.94 52 week Low: $3.78 Most recent dividend: 5.76c Annual dividend yield: 2.5% Franking: 100%

telco

Roger Montgomery's stock pick for the week is Vita Group, an electronics and telecommunications reseller. It also operates 100 Telstra retail stores and 17 Telstra business centres through a master agreement with Telstra.

Originally management expected the Telstra retail stores to generate a run-rate EBITDA (earnings before interest, taxes, depreciation and amortisation) of $250,000 a year at maturity. This was soon exceeded (now over $500,000 a store) and management expects further growth in future. This has been boosted by product launches such as the iPhone and has had a positive effect on Vita's profitability.

This is fine in terms of past performance, but what of the future? From our research, we note the upcoming opportunity for commissions earned by Vita-operated stores as consumers move from the copper network to the NBN network. In a market with about 10 million households, that adds up to a hundreds of millions of dollars in potential commissions.

In addition, consumers are downloading more data than ever on smartphones. While costs per gigabyte of data have gone down, this doesn't appear to have negatively impacted commissions - in fact, commissions and hence earnings per store are rising as Vita cross-sells data plans, warranties, mobile cases and other accessories.

Vita is also pursuing growth in the small and medium enterprise market. Telstra has divided Australia into 78 zones and Vita is seeking to be in 20 to 22 of these with about 30 Telstra business centres.

The firm's competitive advantages include the Telstra brand, which brings a range of benefits. Telstra is a widely recognised name and carries a perception of quality in telecommunications, particularly in terms of mobile reception coverage and connection reliability.

Not many firms in retail can sustain like-for-like EBITDA growth of more than 20% for many years. While this is likely to plateau in future, even more moderate rates of growth are value accretive.

We were fortunate at Montgomery to acquire our shareholding in Vita at levels well below its circa $3.40 price today. In our view there still appears to be upside based on a conservative valuation of future earnings.

Roger Montgomery is the founder and chief investment officer at The Montgomery Fund.

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Roger Montgomery is founder, chairman and chief investment officer of Montgomery Investment Management. Following a successful career as an analyst and public company chairman, Roger published the first edition of his stock market guide, Value.able, in 2010, becoming an Australian best seller in just 16 weeks. He holds a Bachelor of Commerce and is a senior fellow of the Financial Institute of Australasia.
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