Stock in the Spotlight: Telstra

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.

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7 Responses to “Stock in the Spotlight: Telstra”

  1. Albert Meeuwissen says:

    Thanks for the info on Telstra been buying Telstra for some time although some times with much caution. Would ike some information on gma .Regards Albert.

  2. Keat Wong says:

    Well written n rational

  3. Leo says:

    the influx of other telephone providers who focus on niche delivery locations will ultimately lead to the collapse of Australia’s telecommunications industry. What is desperately needed is Government intervention that enforces a set % of minimum coverage by any provider between main cities and country locations. This will help our telecommunications industry to develop sustainability and customer service on a fair platform. I am amazed that our politicians have not realised this basic need, but there again they are not expected to be intelligent but good Machaveliants instead That indulge in who can piss the furthest or barking at each other as they do in public and in parliament.

    • john g says:

      Leos on the money. I would go further and suggest we spend $120,000,000. on a referendum on this subject, even though this subject is of no real importance!

  4. Jim says:

    The article says Clime exited since 2015 and hasn’t cone back. But the bottom line says “Clime group owns shares who n TLS”!
    There is an old saying ‘don’t listen to what the Funds say, look at what they do”.
    Thanks for comprehensive analysis by the way.

  5. james carruthers says:

    Interesting as I have 1/4 M shares in telstra bought when they were $5.70 .
    I believe that telstra will roll out 5 and 6 G which will be much faster than the new nbn
    They dont alwas tell you what but that would be the obvious counter to nbn

    They wont tell you what they have in store, but its a big compny and they wont evaporate overnight. My position is holdfor 2 years, This is all government meddling, the Goverment virtually forced Telstra to open their network so that nbn could plunder the benefits, oce goverment with absklujtely NO BUSINESS SENSE interferes they always stuff it up.

    James CArruthers

  6. john g says:

    Chances of a recovery are slim to none, to much competition and interference, plus tls is like the banks they are a soft target for politicians and uninformed members of the public. Tls has been poorly run since they were privatised and nobody has been held accountable. As long as the dividend was sustained the management was safe, strange they are seemingly still safe.
    They and the competition are unable to manage the technology they currently play with, who in their right mind with their history could believe they can manage 5 & 6G in an effective manner to essentially double their share price.

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