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Elisa Oyj: Defensive, But Expensive

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About: Elisa Oyj (ELMUF), Includes: ELMUY, TELNF, VOD
by: Samu Wilhelmsson
Samu Wilhelmsson
Large-cap, research analyst, long-term horizon
Summary

Finnish ICT-company Elisa has been a solid and a relatively safe investment.

The market environment remains competitive and future growth drivers are modest.

Even by being optimistic, the stock is simply too expensive.

Introduction

Image courtesy of Elisa Oyj

Elisa Oyj (OTCPK:OTCPK:ELMUF) is a Finnish ICT-company that offers its telecommunications services in Finland and Estonia and it currently is the market leader for telecommunications services in Finland. Elisa was founded already in 1882 under the name Helsinki Telephone Association and the company is listed on the Helsinki Stock Exchange with a market cap of 7.8bn euros. The company's global alliance partners are Vodafone (NASDAQ:VOD) and Telenor (OTCPK:TELNF) and its main competitors are other Nordic telecommunication corporations such as Telia (OTCPK:TLSNF).

The company operates within two business segments: Consumer Customers and Corporate Customers. The Consumer Customers segment provides telecommunications services, such as voice and data services for consumers and households. The Corporate Customers segment on the other hand provides voice and data services, ICT solutions and contact center services for corporations. All the services are provided under the Elisa and Saunalahti brands and under various subsidiaries.

Source: Elisa Annual Report 2018

Consumer Customers is the largest segment by having a 63% share of the annual revenue during 2018. Similarly the Consumer Customers segment contributes to over 67% of the company EBITDA. The EBITDA-% for Consumer Customers at the same time was 36% and the EBITDA-% for Corporates, 33%. The company thus operates with relatively stable margins in both of its segments.

Investment case

Source: Yahoo Finance

The stock has been popular among household investors due to its defensiveness. The company has paid out generous dividends and the 5-year return of the stock is +108%.

During the past 5 years, I can't remember a day when the stock would've been considered as undervalued. Due to its nature the stock is in the portfolio of many household investors, investment funds and Finnish pension funds. This has caused historically the stock to trade with a premium compared to its peers. Especially in the current world of low interest rates, more and more investors are engaging into low-volatility stocks like Elisa. This pushes up the valuation even further away from the company fundamentals.

The future outlook of the market environment doesn't support any significant growth to be achieved anytime soon. The revenue of Elisa's mobile services in its Consumer Customers segment has been growing approximately by 2% per year. In the same time the competition in both of Elisa's segments has increased significantly. This has introduced difficulties in increasing the revenue and earnings growth is mainly driven by restructuring activities aimed to increase the profitability of the company and the contribution of past and future acquisition activities.

Source: Author based on the company data

Let's examine a positive case with the company. I'm expecting an annual 1% increase in the company revenue since the market currently hasn't much room for growth and the future growth in the company cash flow leans to the improvements in the company profitability and into its M&A activities. The EBITDA-% is expected to increase slightly during 2019 and also moderately during the next years before achieving a margin of 36% during 2023. During 2018 the EBITDA-% of the company was 35% and the company itself is expecting the margin for 2019 to increase slightly from the level of the previous year.

Source: Author based on the company data

The stock is significantly overvalued

With these metrics, my current valuation of EV/EBITDA of 13x and forward P/E of 24x for the company would indicate that the company trades with a relatively high valuation. The average forward P/E of the sector is at 19x, over 20% under the P/E of Elisa. Even though the dividend yield currently is an attractive 4%, the valuation seems too high to support any engagement into this stock at the moment.

The DCF-analysis for Elisa Oyj is introduced in the table below. If the company manages to improve its operating performance during the next few years, DCF-based fair value per share with my forecasts and with a discount rate of 5.4% is at 45.05 euros. The stock currently trades at 48.51 euros per share which would indicate that in this case the stock trades 7% above its fair value.

2018 2019e 2020e 2021e 2022e 2023e TERM
1 % 1 % 1 % 1 % 1 % 1 %
EBIT 403.5 412.6 422.3 428.4 434.6 440.9
+ D&A 236.2 238.6 240.9 243.4 245.8 248.2
- Tax 65.0 68.8 70.6 71.8 73.0 74,2
- Change in WC 21.4 353.0 1.8 1.8 1.8 1.9
OCF 596.1 935.3 594.5 601.8 609.2 616.8
- CAPEX 229.7 246.1 248.5 251.0 253.5 256.1
FCF 366.4 689.3 345.9 350.8 355.7 360.7 8373.4
Discounted FCF 654.2 311.7 300.0 288.8 277.9 6452.2
EV 8284.9
- Net debt 1170.8
+ Cash 80.9
Fair value 7195.0
Shares outstanding 159.7
Fair value per share 45.05

Author based on the company data

By taking the sector average P/E and my estimation of the forward EPS, we would arrive into a 12-month target price of 40 euros, which would suggest a brutal overvaluation for the stock.

Risks

Many analysts are highly pessimistic on the performance of Elisa's actions and programs designed to improve the company profitability. The consensus target price for the stock is 40 euros per share and it currently has an "Underperform"-rating.

Is there still room to grow? The profitability is already one of the best in the sector and it remains highly uncertain if the profitability could be lifted even further. Also the acquisitions designed to increase the profitability need to be achieved without any failures or unexpected problems.

Conclusion

Even with positive expectations and by being optimistic, the stock still seems to be highly overvalued, and thus my recommendation for this stock is "underperform". The company operates in a highly defensive industry and has been a solid dividend-stock for the Finnish households during tens of years, but now investors aren't encouraged to engage in an investment opportunity with Elisa. Future growth drivers remain extremely modest and don't justify the current valuation of Elisa Oyj.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.