Should you connect your portfolio with this growing telco company?
Uniti Group appears to be your everyday wholesale and retail internet service provider (ISP) on the surface, but dig a little deeper, and you'll also find a significant telecommunications infrastructure business.
So, while Uniti Group offers effectively the same repackaged NBN plans as the other ISPs, it also builds, owns and operates a significant fibre-to-the premises (FTTP) business that services around 350,000 premises across Australia.
Uniti's specialty is the so-called "last mile" infrastructure which connects new residential, commercial and retail sub-divisions to the broader NBN infrastructure. Whilst Uniti tends to fly under investors' radars, it is actually second only to the NBN in terms of FTTP connections. As the demand for new housing expands, and as we continue to live further from major capital city centres, Uniti is well placed to take advantage of these trends.
Since listing in 2019, Uniti Group's share price has tracked its explosive earnings growth.
Part of this growth has come organically, but much of it has also come via a number of strategic acquisitions. FY21 saw some particularly important, company making purchases. The first two significantly bolstered Uniti's FTTP business, including the buyout of FTTP competitor OptiComm and Telstra's FTTP division Velocity, whilst the next most significant purchase, Harbour ISP, bolstered its diversification into the retail internet market.
Much of the hard work is already done integrating these assets into the group. An expected $10 million of annualised cost synergies is on track to be unlocked from OptiComm, whilst 2022 will see the company focus on bedding down Velocity. In our opinion, by the end of 2022, investors are going to be left with a very well-diversified portfolio of growth-oriented telecommunications services assets.
Uniti Group has delivered five straight years of solid revenue and EBITDA growth, and also net profit growth since its maiden net profit in FY20. Its business showed little impact from the pandemic, with net profits growing 270% in FY20 and 147% in FY21.
Looking forward, earnings growth is expected to moderate as the business matures. Still, our forecast earnings per share growth of 20% per annum on average from FY22-FY25 is impressive compared to the broader Australian share market. As a result, Uniti sits comfortably among the ranks of the ASX's top growth stocks.
The only drawback for some investors may be the lack of a substantial dividend yield. It is common for growth-oriented companies to withhold earnings to reinvest back into the business to increase future earnings.
Uniti is definitely in this camp, and we do not expect it to pay a dividend until FY23. Even then, we're expecting only a tiny 0.06% p.a. yield (this will grow to around 0.6% by FY25). Either way, at ThinkMarkets, our investing style favours earnings growth over dividend yield. However, we know many investors prefer income, so we're just pointing this item out.
In terms of its valuation, FY21's PE of 50 times earnings appears high compared to your typical value stocks. But, don't forget the impact of earnings growth! Companies with rapidly growing earnings tend to command higher PE ratios. This is because investors know that when they buy a company the 'P' part of the equation is fixed, but, as the E part gets bigger - the PE ratio must fall. And fall it will for Uniti, to around 25 times earnings by FY25 (think about where we might be in FY26, FY27, and beyond and you'll get the picture with respect to the impact of earnings growth on future value).
Of course, one must be comfortable that a growth company has a sufficient probability of actually achieving its forecast growth, and therefore of reducing its PE to satisfactory level. The chance that the company misses its growth forecasts, and thus ends up being more expensive than initially thought, is known as execution risk. This is a crucial investing concept growth investors must be aware of. Careful analysis of a company's operations and its prospects is required to adequately assess execution risk.
Based upon its earnings growth, its current valuation, and our target PE of 33.8 times earnings, our fair value target for Uniti Group is $4.88. This is sufficient to rate Uniti Group as a BUY. Given the solid track record of the company and our confidence in its capability to execute its strategy, we feel there is a low risk associated with our fair value target, and therefore our rating.
The Uniti Group chart appears to back up our fundamental and valuation conclusions. At the time of writing, we observe substantial demand and limited supply for the company's shares in the form of well-established short and long term uptrends.
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