Stockwatch: A fat yield and growth combo

It's interesting to compare the progress at Mid 250-listed TalkTalk for example with Sky (SKY) as detailed in another Interactive Investor piece.

Including BT Group this orbit of companies is positioned to benefit from telecoms' convergence towards phone, mobile, (fibre) broadband and TV - "quad play" in the industry jargon. It could offer useful growth in years ahead while plenty of other industries may be constrained if "secular stagnation" drags on. It represents a mass-market technology shift that will probably see TV aerials obsolete and content streamed to a wider range of devices.

BT and Sky enjoy pre-tax margins in the high-teens whereas TalkTalk is sub 5% historically; however, Sky in particular has a greater aspect of content subscription. TalkTalk's management deserves attention for its cost-cutting and marketing initiatives now doing well. At the very least this stock will feature on institutional "buy" lists for income, and if management succeeds in its objectives then there is capital upside also from 315p currently.

Strong cash flow profile underpins 4.7% prospective yield

The table shows historic cash flow per share about twice earnings per share, and cost-cutting is boosting it further hence the board is committed to growing the dividend by no less than 15% in the current financial year to end-March 2015. This implies a prospective yield rising to 4.7% with the market price at 315p after a 2014 sideways-volatile trend.

In some respects the chart is typical of many stocks showing QE-driven exuberance in 2013 then consolidation in 2014. Lately it may also reflect caution as to how the competitive struggle will be resolved, although a yield of this extent is anyway respecting some risks. The forward price/earnings (PE) multiple is about 20 times, none too demanding relative to current momentum of 50% annual earnings growth.

Even with a significant moderation of earnings growth TalkTalk should be able to sustain its dividend: the company has made very good progress in telecoms and follows a strategy of being the best-value TV provider in the UK - providing access to the widest range of free and paid-for content. Admittedly, its telephony customer service has been a source of complaints; but looking at reviews for BT and Sky you can find scathing criticism also; meanwhile, one friend who is a TalkTalk customer speaks very highly and versus Virgin. Although perception is mainly of the consumer market, about 20% of group revenue is business-oriented and growing faster than consumer.

My drawing attention is therefore based on TalkTalk's good positioning in a market that can grow usefully in years ahead, with management showing capable actions and the stock offering a meaningful yield.

Notable progression in revenue, margins and cash

The six months to end-September 2014 showed TalkTalk moving closer to its annual revenue growth target of 4%, with a 3.3% revenue rise to £871 million albeit operating profit up nearly 45% to £110 million and operating cash flow by 120% to £44 million - mainly as a result of cost-cutting. Quarterly growth in broadband, TV, mobile and fibre was the fastest in the last four years and management reckoned it is on track for the vast majority of customers to take TV.

Then the third-quarter 2014 results on 3 February showed revenue growth of 4.2% to £449 million so as to be achieving at least 4% in the current year to end-March. Targets for the year to end-March 2017 are 4% compound annual revenue growth with a 25% operating profit margin. Customer churn was just 1.3% and corporate revenue rose 8.0% to £94 million. This was the strongest quarter in three years for take-up of new products, which - bear in mind –- may also reflect buoyant UK consumer confidence with debt rising again.

Yet marketing looks a significant reason also, e.g. TalkTalk's first integrated "quad play" offer last November resulting in an 11% share of the UK SIM market that month. Further mobile propositions have been developed to achieve customer savings over contracts' life, versus the competition. Management appears confident enough to be pushing its prospects to the media which is a good sign.

Deals with Tesco and Virgin typify corporate development

An 8 January deal with Tesco acquired the Blinkbox video streaming business, also Tesco's broadband/phone services. Blinkbox had been established by former Channel Four and Vodafone executives to rival Amazon's LoveFilm and Netflix, although Tesco obviously needs to slim down hence divest. The deal is said to bring immediate benefits. Another interesting development is the competitive collaboration between Virgin Media and Talktalk where some 97,000 subscribers who can't access Virgin's cable network because of where they live, are being transferred to TalkTalk.

Broker price targets vary radically

Among analysts covering the company, share price targets range from 220p to 420p, the lower-end target appearing bizarre considering a yield growing over 4.5% which should limit downside risk. There is not such a big variation in forecasts cited by Company REFS, although its consensus is based on just two brokers. Effectively, such a negative view assumes the present oligopoly of telecoms/media supply will break down into competition so fierce there is little power to set price. Prospects would need to worsen significantly to create corporate financial risk:

TalkTalk had net debt of £555 million at end-September and its net interim interest charge was covered 3.8 times by normalised operating profit. The top-end of share price targeting assumes this area of telecoms/media - and TalkTalk's positioning -offers plenty further scope than a 315p stock price gives credit for.

For more information see talktalkgroup.com/investors.