Australia | Mar 22 2017
Several brokers remain concerned about the outlook for TPG Telecom, despite a fairly robust first half result.
-Growth in net profit and earnings per share may become hard to obtain
-Margin crunch in NBN difficult to avoid and likely to materialise in the second half
-Uncertainty over mobile strategies in Singapore and Australia weighs on outlook
By Eva Brocklehurst
Several brokers are troubled by the outlook for broadband services provider TPG Telecom ((TPM)), given the company's desire to muscle in on a very competitive mobile market. TPG Telecom posted robust revenue growth in its consumer businesses and stable growth in its corporate business in the first half.
Morgans estimates the company's stand-alone operating earnings (EBITDA) growth was 3.9% (ex recent acquisitions) over the first half and 98% of operating cash flow ended up in capital expenditure such as purchasing Singaporean spectrum, Vodafone fibre roll-out and the company's FTTB roll-out.
Given the substantial increase in capital expenditure, depreciation & amortisation is forecast to increase materially over the next few years. Combined with margin pressure from the National Broadband Network (NBN) this means, in the broker's view, that net profit and growth in earnings per share will be hard to come by. Morgans differs from many other brokers in that it expects forecast net profit and earnings per share to actually decline in FY18 and FY19.
On the other hand, the broker notes the company did an impressive job of expanding iiNet's earnings in the first half and has made progress in reducing iiNet costs as well as trying, where possible, to offset the margin crunch that is looming in the NBN. Yet Morgans believes this will be difficult to avoid and become evident in the second half. Consequently, the broker retains a Reduce recommendation.
TPG Telecom has flagged that in the first half its fibre-to-the-building (FTTB) helped offset NBN margin pressure but does not expect this to continue in the second half. Having recently won mobile spectrum in Singapore, the company is expected to expand into mobile in Australia at some stage and this may be as soon as the April 2017 auction for Australian mobile spectrum.
Ord Minnett found the first half results mixed and believes the FTTB opportunity is now at risk, while broadband margins should begin a decline from this point onwards as ii-Net-induced margin improvement has run its course.
The stock is observed trading at a significant premium to its peers on an enterprise value/EBITDA basis as well as on a free cash flow multiple as the company embarks on its Singapore mobile venture. While expecting the company will meet FY17 guidance the broker expects FY18-19 will be tough as the NBN migration accelerates. Ord Minnett's rating is downgraded to Lighten from Hold
Credit Suisse also has a bleaker outlook. While first half results were ahead of forecasts, the broker observes the company continues to lose share, calculating that TPG Telecom accounted for 14% of organic net additions across the market in the first half, which remains below its 25% overall broadband market share and the third consecutive period where share has been lost.
The stock may not be expensive but the risk around its mobile ambitions is significant, Credit Suisse contends. The broker believes the cost of entering the mobile market will be extremely high and the visibility on returns is limited.
The company would then have to build a network, which would require significant investment. Moreover, in the broker's view, TPG Telecom has indicated it is willing to increase leverage to fund any mobile investment. Hence, Credit Suisse downgrades to Underperform.
Morgan Stanley is more positive, keeping a Overweight rating. The broker believes the company is exhibiting best practice in both cost reductions from recent acquisitions and also growing new business. The broker does accept the second half will be more challenging, with accelerated NBN migrations and higher marketing expenses.
First half results beat Citi's estimates, largely because of the improving margins in iiNet. The broker believes corporate, FTTB and other key products which will drive earnings growth in the future as the NBN affects consumers and iiNet.
The broker notes FY17 guidance is unchanged at $820-830m. This probably reflects some conservatism on the part of management, Citi believes, and also the fact that broadband access costs are in the early stages of a steep ramp up during the NBN roll-out.
FTTB
The company is slowing its roll out of the FTTB as it seeks to better understand the impact of the Commonwealth Government's prospective legislation. The reform legislation includes a clause that appears to limit the footprint for FTTB to 50m from its existing network. Credit Suisse believes this could mean that the FTTB strategy may no longer be viable if the addressable footprint is materially reduced.
Macquarie also notes management's concerns over the imposition of the broadband levy and the introduction of the 50m restriction, quoting management commentary that such technology-specific solutions will not solve the problem in question, given the strategies for wireless bypass being implemented elsewhere.
Catalysts
The main catalyst brokers observe is the decision by the ACCC on mobile roaming over the next month and the ACMA auction for the remainder of the 700MHz mobile spectrum scheduled for April 4. At the results briefing the company would not confirm whether it would be bidding at the auction but did indicate a desire not to raise capital to pursue an Australian mobile strategy.
While both Goldman Sachs and Citi expects TPG Telecom will bid for spectrum, their base case assumes that Optus and Vodafone secure the two available blocks.
UBS believes TPG is likely to participate and, if successful, estimates a metro-centric roll-out could cost $1.5bn and upwards, with cost dependent on how much spectrum is acquired and the extent to which the company builds the network rather than leases infrastructure. This is also dependent on whether TPG Telecom can roam onto other networks.
Corporate revenue growth picked up to 3.8% and Macquarie believes corporate is a key driver of earnings going forward, following the network expansion facilitated by the Vodafone roll-out. Cash conversion was also consistent with historical levels.
That said, the uncertain prospects surrounding the company's mobile strategies in Singapore and Australia overshadow the stock and this has implications for the earnings outlook, cash flow and risk profile, in the broker's opinion.
Capital expenditure was above the broker's expectations as the company starts to build a local team in Singapore. Capital expenditure guidance for Singapore mobiles in FY17 is $120-160m, which include spectrum payments and network capital expenditure for the year but excludes any potential spectrum payments from the Singaporean general spectrum auction early this year in the event the company is a successful bidder.
FNArena's database shows three Buy recommendations, two Hold and three Sell. The consensus target is $7.89, suggesting 16.1% upside to the last share price. This compares with $8.04 ahead of the results. Targets range from $6.03 (Morgans) to $10.75 (Morgan Stanley).
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