Thursday, August 2nd, 2018
Telstra shares are down 31% over the last year and the dividend cut heightened the pain, with the former longstanding and prized 31-cent per share annual dividend now only a memory. The company’s problems are well-known: falling revenues from disconnections of the fixed line business only partly offset by compensation payments from the NBN, migration of this traditional business to much less profitable NBN reselling, plus margin pressure and declining growth in the lucrative mobile business as competition intensifies.
At Telstra’s June strategy day management delivered on investors’ every request in recent months: aggressive staff and cost cuts, a rebase of mobile earnings to compete harder for market share and a first step towards structural separation of the infrastructure assets. However the share price has not changed since the announcements, which means investors either do not expect management will execute or the benefits of Telstra2022, the strategy’s name, will be offset by further deterioration in the underlying business.
After the much weaker 2019 earnings guidance announced with the new plan, the shares are now trading at a reasonable valuation in the most likely scenario for the core business. In our view the risk is out of the stock at $2.50 and there is upside to $3.50 if management executes well and NBN and mobile trends improve. However these and other positive catalysts for Telstra are post-2020, with 2019 likely another hard year for shareholders as revenue, earnings and the dividend again diminish. It is hard to predict where the dividend, so influential on this company’s share price, bottoms so our estimate is a range: 14-18 cents per share in 2019 and thereafter. Our model portfolio exited Telstra at $5.50 two years ago and we have not returned.
Telstra created a new wholly owned business unit, ‘InfraCo’, to house its non-mobile infrastructure assets. This gives more options after the NBN’s rollout ends, including a demerger and spinout to shareholders, entry of a strategic investor or even M&A with the NBN itself – though the government has currently ruled out Telstra acquiring the NBN. There was some initial excitement the creation of InfraCo could automatically propel Telstra’s share price higher as investors valued InfraCo on the same multiples as similar offshore fibre telecom companies. However this has not happened given InfraCo is so far only a change in reporting structure. We think Telstra will have to do something new and meaningful with InfraCo for the market to price its potential value. For the moment the new vehicle only has longer-term strategic value.
Telstra said it would be 5G “network-ready” in the first half of 2019. This was much sooner than we expected and it increases our interest in the stock. The bullish case for Telstra has always involved the creation of competitive advantage in 5G, particularly bypass of the NBN. Telstra’s prediction 25-30 per cent of the fixed market could migrate to 5G seems reasonable and will probably be built into consensus earnings estimates as a base case. The question is how long it takes Telstra to achieve and what margins are possible.
At the headline level, the Telstra2022 strategy is the best course of action for the long term and was certainly better than doing nothing, which would have seen Telstra lose share before having to cut data charges anyway. Near-term there are few reasons for the stock to rally unless Telstra can demonstrate underlying earnings bottom in 2019. This is possible but unlikely because it would require mobile market share gains and/or higher revenues per user, and cost savings above target.
Industry consolidation, where the most likely scenario is a merger between Vodafone and someone else, would encourage more rational pricing but could first require a price war that weakens Vodafone to the point it succumbs. Telstra’s cashflows place it in the strongest position to survive a price war but earnings would take another heavy hit in the meantime.
Looking further out, Telstra’s cost savings and 5G monetisation are post-2020 benefits not yet priced into the stock. The question is whether underlying earnings momentum continues to deteriorate in the meantime, offsetting them.
Clime Group owns shares in TLS.