M2 Telecommunications (MTU.AX) delivered strong results across their businesses in 2009-2010. With underlying EPS up 72% to 16.7cents on the back of the People Telecom acquisition and organic growth. 2011 forecasts were strong with underlying EPS targeted in the 20.7-22c range.

With the current price of $1.80 you’re buying earnings growth of 28% for a P/E multiple of 8.4, which is an appropriate multiple for a no-growth company. In others words, current buyers are getting all M2′s growth for free. Alternatively the market believes M2 is not going to grow in the future despite their excellent management, strong history of growth and strong position in the changing telecommunications market. I think the market is wrong, YMMV.

The final dividend is 5c bringing the combined 2010 dividend to 10c, an 82% rise on 2009. That represents a fully franked yield of 5.6%. As M2 has a stated 70% payout ratio the forward dividend yield is 8.3%, based on their eps and payout guidance.

A Quick Look Behind the Numbers

Return on equity is increasing pushed by many financial commentators as “the number”. I don’t believe any single number adequately captures a companies value.  Even a justifiably good albeit problematic number like ROE is better viewed as the sum/product of its parts. While most of my readers probably know the constituents of ROE, I’ll go through it with M2′s numbers so everyone can get some benefit.

ROE is easily calculated by dividing profit by average equity, hence return on equity. However, that is not what I mean by constituent parts. ROE is more meaningfully viewed as the product of  profit margin times asset turnover time financial leverage. The first two items, profit margin and asset turnover give you return on assets (ROA).

Let’s run through the key numbers you need for M2, in thousands.

From those four figure we can calculate

The product of those constituent parts give an ROA of 10% and ROE of 21%. Once you’ve got those ratios you can look for trends over time and use them for comparison to similar companies. That’s when the numbers actually become useful. In M2′s case the profit margin and asset turnover increased while financial leverage decreased (2009 figures respectively 3.64%, 1.43 and 2.92 giving an ROA of 5% and ROE of 15%). From that we can hazard a guess that management are improving the business while simultaneously reducing the risk, which is what I like to see.

Interest coverage, current ratio and the acid test are three liquidity ratios worth keeping an eye on.

To calculate those we need a few more numbers

• EBIT 26,411
• Interest 2,244
• Current Assets 78,466
• Current Liabilities 66,473
• Inventory 338

To give us

• Interest coverage: EBIT/Interest is 11.8, which means M2 earns over 11 times the amount they need to cover interest.
• Current ratio: Current assets/current liabilities is 1.18, which means M2′s assets which should convert to cash within the next year can cover their liabilities due within the next year.
• Quick ratio:  (Current assets – liabilities)/current liabilities is not really required for a company like M2 with low inventories, as it is almost the same as the current ratio. The quick ratio is generally more useful for companies that sell stuff, as that stuff (inventory) is less further away from being converted to cash and in the event of distress is likely to be heavily reduced.

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Related Documents

• M2 2010 Investor Presentation
• M2 2010 Earnings Press Release
• M2 2010 Annual Report
• Vaughn Bowen discusses 2010 results on BRR

Disclosure: Long MTU

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