Gambles of the week: TalkTalk and John Menzies

TalkTalk Telecom (LSE: TALK)

I’ve found it difficult to recommend buying TalkTalk Telecom over the last few years. While it’s not a bad business, I’ve never thought the shares were cheap enough. They are still not particularly cheap now: at a price of 295p, they trade on nearly 23 times 2015 expected earnings per share (EPS).

However, for some time City analysts and commentators have suggested that TalkTalk might be a tempting takeover target. The company has been making decent progress in recent years and the problems of terrible customer service seem to be firmly behind it.

This has allowed it to carve out a niche as a value provider of telephone, broadband, TV and mobile-phone services – known in the trade as ‘quad play’.

By offering services as a bundle, it is easier for companies such as TalkTalk, BT, Virgin Media and Sky to hang on to their customers and win new ones.

This could be a problem for companies such as Vodafone, which last week announced that it was going to start offering home broadband and TV services in an attempt to hold on to its customers.

TalkTalk Telecom share price chartVodafone has cash to burn, following the sale of its stake in Verizon Wireless, and buying TalkTalk, with its four million customers, might help it overcome that problem.

But one sticking point in this scenario might be TalkTalk’s decision to partner up with O2 to run its mobile-phone business, as announced this week. An alternative possibility is that Sky might be tempted to bid – if regulators would allow that.

Without a takeover, TalkTalk looks more like a share for income seekers. It hopes that it can become more profitable in the years ahead, by bearing down on costs and generating higher profits from new customers.

The company pays out most of its profits in dividends, which are set to grow by at least 15% this year. On a 4.6% yield, that doesn’t look too shabby in this low interest rate world.

Verdict: a speculative buy

John Menzies (LSE: MNZS)

My buy tips on aviation and logistics services group John Menzies have been embarrassingly wrong. Three weeks ago, I thought the shares looked very cheap and were worth buying. Shortly afterwards, the company issued another profits warning and the price tanked again.

The aviation services business is struggling with some problem contracts and will make a lot less money than management thought it would. Next year’s profits will be lower than expected. So where does this leave the shares now?

The aviation services business is clearly risky and may get worse before it gets better. But it’s difficult to argue the shares are more risky now that they are 25% lower than they were three weeks ago.

At a share price of 350p, taking the lowest analyst estimate for 2015 EPS of 46.9p would put the shares on a forward price-to-earnings ratio of 7.5 times.

At the risk of sounding foolish, I think the dividend will be held at last year’s level of 26.5p per share, since the news distribution business still generates lots of free cash flow to pay it. That puts the shares on an attractive dividend yield of 7.6%.

Verdict: buy