Investor: An insider's guide to the market. Global stock markets continue to edge higher in the aftermath of the US presidential election combined with better news from the US economy and signs that oil prices are decisively retreating from the $50 (€38.53) per barrel level.
While the US economy seems to be regaining some momentum, the euro zone and Japan experienced sluggish growth over the third quarter. Euro-zone gross domestic product (GDP) expanded 0.3 per cent in the third quarter, which was the slowest quarterly rate of growth since the global economy rebounded in the second quarter of 2003.
Nonetheless, European equity markets have been able to advance over the past month and the local currency year-to-date returns for European indices and the S&P 500 are similar at around 7 per cent.
This week the UK's FTSE 100 index broke through the 4,800 level for the first time in 29 months. Strength in mobile phone stocks MMO2 and Vodafone led a broad-based advance.
Telecoms stocks have been performing well recently and in Ireland the Eircom share price has risen by 14 per cent over the past three months. This is still only 5 per cent above the issue price of €1.55.
The recent improved performance of European telecom stocks has been driven by optimism regarding the mobile side of the business. Vodafone is preparing to finally launch its 3G service to a mass audience and this is creating renewed investment interest in the sector.
Of course, Eircom does not have a presence in the mobile sector and, therefore, it is not currently in a position to profit from wireless growth opportunities.
Eircom is the principal provider of fixed-line voice and data communications services in Ireland. The company has approximately 1.9 million fixed-line telephone access channels and it is also the largest internet service provider with in excess of 500,000 subscribers.
In the absence of a mobile or wireless offering, the rollout of broadband services offers the only significant growth opportunity for Eircom.
Whilst Eircom will remain the dominant player in the fixed-line market, call volumes and pricing will be under severe pressure from wireless substitution and other competitive threats.
Eircom has been partially successful in offsetting the erosion in the profitability of the fixed-line business through the rollout of broadband. The company seems set to achieve or exceed its target of 100,000 customers by year-end.
The Government is very keen to dramatically increase the penetration of broadband and has set a target of 500,000 broadband connections by 2006. While Eircom will have to fight hard to win its share of the market, it is well placed to remain the dominant player.
In addition to broadband rollout, Eircom will need to find a way to re-enter the wireless or mobile sector. Its management has stated that it is actively exploring options in this regard.
One option is to become a virtual operator by purchasing "space" from one of the existing mobile companies. Eircom has been lobbying the regulator to force the mobile operators to reduce their access rates.
Another option facing Eircom is to attempt a takeover of Meteor, the third operator. However, Eircom's eventual wireless strategy will be constrained by its balance sheet where debt stands at €1.9 billion.
In addition, the company is committed to paying a high dividend so that large interest and dividend payments will have first call on the company's operating cashflow for the foreseeable future.
From an investment perspective, Eircom's key attraction is its very high dividend yield of 6.7 per cent. This is well above the market average and is also well above the 4.5 per cent yields offered by the financial sector stocks. However, financial stocks look capable of growing their dividends by at least 10 per cent per annum into the medium term.
In contrast, there is little prospect of any meaningful growth in Eircom's dividend for at least three years. Indeed, some analysts have questioned whether the company will generate sufficient cashflow to maintain the dividend at its current level.
Beyond the next two-three years, the investment case for Eircom rests on how successful it is in growing its broadband business and on whether it can profitably re-enter the wireless sector.
In the meantime, the company can slow the decline in profits from the fixed-line business through a relentless drive to reduce costs. Investor takes the view that Eircom offers investors an attractive exposure to the Irish telecom market.
The Irish economy, which is forecast to grow at 5 per cent per annum over the medium term, will generate a growing demand for telecommunications services. Competitive pressures will intensify but Eircom can perform well if it becomes more efficient and if it is successful in broadband and in its re-entry to the mobile market.
The critical investment negative is that the company is on a financial tightrope due to its very high level of debt.
On balance, Investor considers the shares to be worth buying given the positive outlook for the Irish economy, the current dividend yield of 6.7 per cent and the potential for growth in two-three years if Eircom successfully executes its broadband and mobile re-entry strategy.
