Description of the companies

From the perspective of an overseas institutional investor, the report would analyse the investment opportunity in the market of Australia. The two companies selected in order to fit the purpose of the report are Telstra Corporation Limited and TPG Telecom Limited. Initially, a discussion would be conducted on analysing the business operations of these organisations by identifying their comparative benefits. After this, the profitability and liquidity positions of these two companies would be assessed based on certain ratios for the previous three years by extracting necessary information from their annual reports. The next segment would focus on the evaluation of the share price movements of these companies in order to determine their volatilities in stock prices by distinguishing them with the All Ordinaries Index for the three-year period. Along with this, the weighted average cost of capital (WACC) of the chosen companies has been computed so that their capital structure could be evaluated appropriately. Lastly, the concerned investor would be recommended regarding the future investment prospects in the two organisations in the form of a letter of recommendation.

TPG Telecom Limited is involved in providing telecommunication services to both medium and small organisations, big corporate entities, residential users, wholesale customers and government in Australia and other international countries. Along with this, the other offerings of the organisation include Ethernet broadband and fibre optic, ADSL2+, NBM, telephony services, mobile plans for SIM only, internet protocol television and various solutions pertaining to business networking. Furthermore, the various bundle plans comprising of internet products, internet messages and POP3 across the protocol mail accounts have definitely added to its advantage in the market. In August 2018, an expected merger has been announced, in which Vodafone Hutchison Australia and TPG Telecom Limited would function as a single company. The latter would have 49.90% of the total stake and this is definitely a comparative advantage for the organisation (Tpg.com.au 2019).

Telstra Corporation Limited offers telecommunications and information services to the governments, communities, businesses and individuals in Australia and other international nations. It provides sales as well as contract management services for medium and large organisations, government customers and product management services in relation to advanced technology services and solutions. These include internet and data protocol networks, cloud, industry solutions and others. Since the deregulations of the Australian telecommunications sector in 1990, the organisation is the leading provider of telecommunication services in Australia despite the emergence of its rival, Optus. It has adopted a strategy of offering lower rates at few routes and in few times of day although the prices have been more than rivals. This has helped the organisation in retaining different points of market share (Telstra.com.au 2019).

Comparative analysis of liquidity and profitability

In order to make sound investment decision, both profitability and liquidity positions of an organisation are to be analysed (Bandy 2014). Both Telstra Corporation Limited and TPG Telecom Limited are not exceptions to this fact and therefore, the profitability and liquidity ratios of the organisations are to be computed. The detailed calculations and analysis of these ratios are provided as follows:

In order to conduct the profitability analysis of Telstra Corporation Limited and TPG Telecom Limited, there are three ratios considered for analysis and they include operating margin, return on capital employed and net margin. The detailed breakdown of these ratios for the two organisations is presented as follows:

Table 1: Profitability ratios of Telstra Corporation Limited and TPG Telecom Limited for the years 2016-2018

(Source: Telstra.com.au 2019: Tpg.com.au 2019)

Figure 1: Profitability ratios of Telstra Corporation Limited and TPG Telecom Limited for the years 2016-2018

(Source: Telstra.com.au 2019: Tpg.com.au 2019)

With the help of operating margin, it becomes easier to identify the profit proportion of an organisation after all direct and indirect costs are deduced except income tax expense and interest expense (Baños-Caballero, García-Teruel and Martínez-Solano 2014). For Telstra Corporation Limited, operating margin is observed to fall from 23.33% in 2016 to 19.46% in 2018. However, for TPG Telecom Limited, the ratio after experiencing increase from 24.08% in 2016 to 25.45% in 2017 has fallen again to 23.97% in 2018. Thus, by considering all the above figures, TPG Telecom Limited has generated more revenue compared to Telstra Corporation Limited and thus, it has offset its operating costs appropriately.

Net margin signifies the portion of profit generated by a firm after settlement of all expenses comprising of direct costs, office expenses, finance costs and income tax expense (Barr and McClellan 2018).  For Telstra Corporation Limited, net margin is observed to fall drastically from 21.62% in 2016 to 12.15% in 2018. On the other hand, in case of TPG Telecom Limited, the net margin has increased from 15.50% in 2016 to 19.96% in 2018 owing to lower operating costs incurred compared to Telstra. Thus, in terms of net margin, the position of TPG Telecom Limited is observed to be better in the Australian telecommunications sector (Petty et al. 2015).

This ratio is considered as a method for contrasting profitability throughout the firms based on the amount of used capital (Bekaert and Hodrick 2017). In case of both organisations, the ratio after witnessing mild increase in 2017 has declined considerably in 2018. However, the ratio for Telstra Corporation Limited is still found to be higher than TPG Telecom Limited. This implies that Telstra is able to generate higher returns on capital employed and hence, the shareholders would receive better returns than TPG Telecom.

Share price movement analysis

In order to conduct the liquidity analysis of Telstra Corporation Limited and TPG Telecom Limited, there are two ratios considered for analysis and they include current ratio and quick ratio. The detailed breakdown of these ratios for the two organisations is presented as follows:

Table 2: Liquidity ratios of Telstra Corporation Limited and TPG Telecom Limited for the years 2016-2018

(Source: Telstra.com.au 2019: Tpg.com.au 2019)

Figure 2: Liquidity ratios of Telstra Corporation Limited and TPG Telecom Limited for the years 2016-2018

(Source: Telstra.com.au 2019: Tpg.com.au 2019)

Current ratio assists in identifying the capability of a firm to clear its current obligations with the short-term asset base available (Bhalla 2014). For Telstra Corporation Limited, the current ratio has fallen from 1.02 in 2016 to 0.86 in 2017 and the decline is further to 0.80 in 2018. The trend is similar for TPG Telecom Limited, in which decline in current ratio could be observed from 0.70 in 2016 to 0.37 in 2017 and further decline could be observed to 0.26 in 2018. In this case, it is necessary to mention that the ideal standard of current ratio is considered to be 2 (Bodie 2015). Since there has been rise in spectrum liability in 2018, the current ratio for TPG Telecom Limited has declined significantly, while the fall in cash balance and trade receivables has been the reason behind the poor current ratio of Telstra Corporation Limited. However, the position of Telstra is found to be more favourable compared to TPG Telecom in terms of current ratio.

Quick ratio is considered to be more useful compared to the current ratio for the investors, since it does not consider prepayments and inventories while analysing the liquidity position of an organisation (Brigham and Daves 2014). In case of Telstra Corporation Limited, quick ratio is observed to be declining over the years from 0.91 in 2016 to 0.65 in 2018. The trend is similar for TPG Telecom Limited as well where the ratio is observed to be falling from 0.64in 2016 to 0.24 in 2018. An ideal quick ratio is considered to be 1 for any organisation (Brigham et al. 2016). In case of both the organisations, the ratio is below the ideal margin; however, it still seems to be close for Telstra than TPG Telecom. This is because Telstra has attempted to estimate its inventory based on the current market demand.

Hence, in terms of liquidity position, the performance of Telstra Corporation Limited is deemed to be better in comparison to TPG Telecom Limited in the Australian telecommunications industry.

Calculation of WACC

Figure 3: Monthly share price movement of Telstra Corporation Limited and All Ordinaries Index for the years 2016-2018

(Source: Au.finance.yahoo.com 2019: Au.finance.yahoo.com 2019)

As per the above figure, the movements in stock prices of Telstra Corporation Limited and All Ordinaries Index could be found between 2016 and 2018. The evaluation clearly states that the stock price performance has improved in the three-year period. It has been found that the share price of Telstra Corporation has complemented the increase in share price of the All Ordinaries Index despite the fact negative correlation could be found between the stock price of the concerned organisation and the index. The increase in stock price of Telstra Corporation Limited signifies a favourable trend expected to increase further in future and as a result, the investors would be able to earn maximum returns on investments made in the shares of the organisation. However, the correlation between the share price of Telstra Corporation Limited and All Ordinaries Index is found to be negative at -0.815.

Figure 4: Monthly share price movement of TPG Telecom Limited and All Ordinaries Index for the years 2016-2018

(Source: Au.finance.yahoo.com 2019: Au.finance.yahoo.com 2019)

After carefully analysing the above figure, it could be identified that the share price of TPG Telecom Limited has fallen considerably compared to the stock price movement of the All Ordinaries Index. This showcases the fact that the share price of the organisation has not been able to show movements according to the changes in stock price of the All Ordinaries Index. This signifies all issues in the current demand among the potential investors (Vernimmen et al. 2014). Thus, the comparison between the share price of the concerned organisation and All Ordinaries Index denotes a low chance of likely increments in share price of the organisation. Moreover, it is validated further by the negative correlation observed between the stock price of TPG Telecom Limited and All Ordinaries Index, which is identified as negative at -0.586.

Table 3: WACC of Telstra Corporation Limited

(Source: Telstra.com.au 2019)

With the help of the above calculation, the weighted average cost of capital of Telstra Corporation Limited could be identified between 2016 and 2018. Moreover, it is clearly observable that the values of WACC have changed from 8.61% in 2016 to 8.44% in 2018. Such relevant decline in the weighted average cost of capital is primarily due to the fall in the weight of equity from 36.75% in 2016 to 35.02% in 2018. The capital structure composition of the firm has been modified in the existing year of the three-year period, in which the exposure of debt has risen from 63.25% in 2016 to 64.98% in 2018. In a similar manner, as discussed above, there has been decline in the exposure of equity of the organisation due to the rise in the overall debt weight over the years. Thus, it clearly validates the fact that Telstra Corporation Limited raises majority of its funds through debt for financing its assets (Wang 2014). Moreover, it could be identified that the cost of equity is considerably high despite the fact that the cost of equity is considerably high. As a result, the use of debt capital has resulted in increase in overall cash outflows of the concerned organisation. In this regard, it is noteworthy to mention that the firms could make sound decisions regarding investment proposals and project selection, which would generate additional returns in contrast to the weighted average cost of capital (Cornwall, Vang and Hartman 2016).

Analysis of capital structure policy and leverage

Table 4: WACC of TPG Telecom Limited

(Source: Tpg.com.au 2019)

The calculations conducted in the above table have direct impact on the weighted average cost of capital of TPG Telecom Limited. The WACC is calculated for three years, in which it has been found that the same has increased from 9.67% in 2016 to 11.10% in 2017; however, it has fallen again to 10.12% in 2018. The proportion of debt after declining significantly in 2017 has risen again in 2018. Hence, the trend seems to be fluctuating for the concerned organisation. As a result, stability could not be observed in the debt and equity weights of the organisation over the periods, which have exercised influence on the overall weighted average cost of capital. In case, there is rise in the cost of capital, there is reduction in the financial capability of the firm when additional investment projects are acquired. In the words of Karadag (2015), with the help of weighted average cost of capital, the investors could detect the minimum needed rate of return that is required to be accomplished by the organisation in order to assure sound growth.

In order to conduct the capital structure analysis of Telstra Corporation Limited and TPG Telecom Limited, there are two ratios considered for analysis and they include debt to equity ratio and interest cover ratio. The detailed breakdown of these ratios for the two organisations is presented as follows:

Table 5: Capital structure ratios of Telstra Corporation Limited and TPG Telecom Limited for the years 2016-2018

(Source: Telstra.com.au 2019: Tpg.com.au 2019)

Figure 5: Capital structure ratios of Telstra Corporation Limited and TPG Telecom Limited for the years 2016-2018

(Source: Telstra.com.au 2019: Tpg.com.au 2019)

Debt to equity ratio:

This ratio assists in measuring the financial leverage of a firm by dividing the total liabilities by total equity of an organisation (Khan 2015). When the ratio is 1 or below 1, it is deemed to be favourable for any business organisation. For Telstra Corporation Limited, the ratio has been well above 1 in all the three years, while the ratio has been below 1 for TPG Telecom Limited in 2017 and 2018. Hence, it has been found that Telstra Corporation Limited focuses on debt for obtaining its funds, while TPG Telecom Limited uses equity for funding majority of its assets. As a result, the financial leverage of Telstra is found to be considerably higher in contrast to TPG Telecom and hence, the investors of the former have to bear additional risks in their investments (Zietlow et al. 2018).

This particular ratio assists in assessing the capability of a firm to settle its finance expenses by using its operating profit (McKinney 2015). For Telstra Corporation Limited, the interest cover ratio has risen from 8.89 in 2016 to 10.55 in 2017; however, it has fallen slightly to 10.29 in 2018. If the ratio is found to be above 1, it means that the organisation has the ability of settling off its interest expenses effectively (Otley 2016). On the contrary, the ratio is observed to increase considerably over the years from 7.17 in 2016 to 17.39 in 2018.  

Hence, in terms of capital structure, the position of TPG Telecom Limited is found to be more favourable than Telstra Corporation Limited owing to minimised financial risk and increased financial ability in settling off its finance expenses (Rossi 2014).

The considerable evaluation of the overall financial performance, capital structure, share price performance and WACC positions of Telstra Corporation Limited and TPG Telecom Limited, Telstra is more suitable for the client in terms of investment purpose. There has been significant growth in the international telecommunications sector and as a result, the investors could use this opportunity for earning enhanced level of income. The primary reason that Telstra Corporation Limited is selected has been due to the better liquidity position and share price performance than TPG Telecom Limited. However, it is lagging in profitability and financial leverage aspects compared to TPG Telecom. On the other hand, Telstra Corporation Limited possesses the ability of settling it due payments more effectively compared to TPG Telecom Limited. This means that the organisation is more capable of settling its borrowings effectively.

Hence, the investors would be able to undertake better investment decisions of selecting an investment alternative that would help in enhancing the entire return of the particular investor. In addition, the share price performance of Telstra Corporation Limited is found to be better, as TPG Telecom Limited is witnessing a sharp increase in the recent times. This sign is deemed to be positive for the investor, as it would in increasing its overall return on investment. Moreover, even though Telstra is lagging behind TPG Telecom Limited in terms of interest cover, the ratio is still suitable for the former due to its ability of clearing its finance expenses. Based on all these aspects, the investor is advised to invest in the shares of Telstra Corporation Limited so that its overall return could be maximised in future.

Conclusion:

Considering the above-discussed facts, it could be stated that in terms of liquidity position, the performance of Telstra Corporation Limited is deemed to be better in comparison to TPG Telecom Limited in the Australian telecommunications industry. Moreover, Telstra is able to generate higher returns on capital employed and hence, the shareholders would receive better returns than TPG Telecom. It has been found that the share price of Telstra Corporation has complemented the increase in share price of the All Ordinaries Index despite the fact negative correlation could be found between the stock price of the concerned organisation and the index. The considerable evaluation of the overall financial performance, capital structure, share price performance and WACC positions of Telstra Corporation Limited and TPG Telecom Limited, Telstra is more suitable for the client in terms of investment purpose. Based on all these aspects, the investor is advised to invest in the shares of Telstra Corporation Limited so that its overall return could be maximised in future.

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