Choosing the right industry is often as important as selecting the right stock. Despite the recent rally, many retailers, banks and homebuilders are still on their knees. So I try to concentrate on other sectors where there is growth at attractive valuations. One such area is the internet.
Two recent industry research reports caught my eye. The first, from Cisco, forecasts a fivefold jump in web traffic between 2008 and 2013 (or 40% per year). This will be driven by the soaring popularity of bandwidth-hungry websites such as YouTube and the BBC’s iPlayer.
The second report, from Alcatel-Lucent, claims that 84% of consumers worldwide are unwilling to part with broadband, preferring to cut expenditure elsewhere rather than lose online access.
Enter Cable & Wireless, Britain’s second largest telecoms group. It has changed a lot since the dotcom era and is now split into two separate entities.
Cable and Wireless (LSE: CW), rated BUY by Astaire Securities
The smaller, but more profitable, business is the International unit, which generates 38% of sales. It provides mobile, broadband and fixed-line services in the glamorous hotspots of Monaco, the Caribbean, Panama and Macau. The group is well established in those locations and has benefited from the strength of the American dollar. This effect has been partly offset by declines in local GDP and falling tourist numbers.
Meanwhile, the recession is proving to be a boon for its Worldwide division (62% of sales). This provides high-speed voice, data and hosting services to clients such as Morrisons and Centrica. As these companies seek to trim costs, they are outsourcing more of their in-house telecoms activities to specialists such as Cable & Wireless.
The firm should also get a boost from lower client turnover as customers migrate to the safety of larger players. Troubles at industry behemoth BT, coupled with smaller outfits quitting the sector, will also help. That Cable & Wireless secured a prestigious £207m, 15-year contract in June to run a state-of-the-art fibre-optic network to control the National Grid is evidence of these trends.
The board is predicting a 21% jump in cash profits (assuming constant exchange rates) in 2009, with revenues and Ebitda coming in at around £4.1bn and £1bn respectively. On this basis I would value the group on a seven-times Ebitda multiple. After deducting net debt of £377m and applying a discount rate of 12%, this suggests an intrinsic worth of around 250p per share.
This is around 80% above the current price. And for income-seekers there’s a 6% dividend yield. Unlike many of its rivals, Cable & Wireless doesn’t carry onerous pension liabilities after off-loading its British scheme to Prudential in 2008.
Of course, no share is risk-free. Cable & Wireless operates in a fast-moving environment and is going head-to-head against giants such as Deutsche Telecom. There are also foreign currency and regulatory risks. Nonetheless, with prospects looking up and the industry anticipating improved demand and profit margins, the shares look appealing. Finally, the highly focused management team has recently indicated that the two major business divisions may be demerged. That could be the catalyst needed to move the stock northwards.
So keep an eye out for the next trading statement due on 17 July.
Recommendation: BUY at 128.5p
• Paul Hill also writes a weekly share-tipping newsletter, Precision Guided Investments