Wireless More Significant For Telstra, NBN

This story features TELSTRA GROUP LIMITED. For more info SHARE ANALYSIS: TLS

Telstra has downgraded revenue and earnings estimates for FY18 in view of the NBN decision to delay the roll out of HFC technology. Yet several brokers remain more concerned about the increasing influence of wireless.

-NBN delays not hugely significant for Telstra's valuation
-But indicative of the sensitivity of reported earnings to one-off NBN payments
-Wireless technologies a threat to the NBN model
 

By Eva Brocklehurst

In response to the NBN decision to delay the roll out of HFC technology for 6-9 months, Telstra ((TLS)) has reviewed its earnings outlook for FY18. If it were not for the NBN announcements guidance would be unchanged, as the company has indicated there is no change to the performance of operations.

Revenue estimates for FY18 are lowered by -$700m and operating earnings (EBITDA) by -$600m. This indicates a downgrade of around -2% and -5% at the mid point of guidance, respectively. Telstra suggests the delay will be modestly positive, financially, over the full rolling out of the NBN. In other words, one-off payments will be received just a little later, and the company would obtain the benefits from using its existing higher-margin infrastructure for longer.

There was nothing in Telstra's update to change Morgan Stanley's fundamental view and Underweight rating, noting, if nothing else, the situation is indicative of the sensitivity of reported earnings to the one-off payments from the NBN.

Macquarie also finds, on an underlying basis, there is little changed, as the majority of the impact is a timing difference. The broker calculates much of it will reverse in FY19, although acknowledges the timeframe over which the NBN plans to catch up is unclear.

Macquarie upgrades Telstra to Outperform as the dividend is underpinned by NBN payments over the medium term and the yield should provide support. The thesis of yield support holds on the basis that Telstra can hold, or grow, its dividend.

Morgans assumes the delays will have a knock-on effect in FY19, reducing FY18 forecasts for earnings per share by -10% and FY19 by -6%. The broker believes investors are not paying for any potential upside around competing technologies and downside is priced into the valuation. Telstra is considered to have a partial natural hedge on the NBN, so the delays are not drastic to valuation, and this is one of the key reasons Morgans has an Add rating.

Citi has a different take. The broker is surprised the downgrade to operating earnings is so large, which implies that either the natural hedge is less effective than previously expected or there has been further deterioration in the core business since original guidance was issued in August.

NBN delays are positive for core earnings, the broker admits, as Telstra retains its copper network earnings. Citi's estimates for earnings per share are reduced by -10% in FY18 and -4% in FY19, while FY20 is upgraded 13% on the assumption that the NBN will still hit its FY20 targets.

Wireless

While 80% of the revenue from the NBN roll out has been delayed, Citi estimates 20% of this is a permanent loss, given NBN has increased its allocation to wireless and will not pay Telstra for disconnecting the copper network in those areas.

Wireless technologies are a real threat to the NBN model, Morgans agrees. Australia may languish in respect of fixed-line speeds but it is in the top 10 for mobile speeds globally. Moreover, the introduction of 5G and other wireless last-mile technologies, which are not going to be regulated, are a real threat to the NBN, and Morgans suggests its financial model may fail. The broker asserts the NBN will have to lower the last-mile access price, which would ultimately be a positive for telco earnings.

This could happen in FY22, or even earlier, when the last customer is forced onto the NBN and numbers are solidified. Morgans considers the NBN a political hot potato and, if the government wrote off the $30m in equity invested and lowered last-mile access costs this would solve a significant part of the speed problems. As Telstra shares are trading -12% lower since the FY17 result, Ord Minnett also takes a look at what catalysts are required to lift the stock.

The broker agrees, given an impending new entrant on the mobile side, the catalyst will have to come from a change in the NBN business model and it would be in the best interests of the country if the government lowered its expected return on the investment in the NBN to allow a focus on service rather than profitability.

The government would have to write down some of its investment and the broker estimates 30-50% potential upside to Telstra share price if such an event occurred. The other catalyst could be a reduction in fees imposed on internet service providers to access the NBN network. The impact on Telstra would be similar, albeit on a smaller scale. In this scenario, Ord Minnett estimates 20-30% potential upside to the share price.

FNArena's database shows four Buy, two Hold and two Sell ratings. The consensus target is $3.78, suggesting 9.0% upside to the last share price. Targets range from $3.25 (Citi) to $4.11 (Morgans). The dividend yield on FY18 and FY19 forecasts is 6.3% and 6.4% respectively.

See also, NBN Delay Largely Neutral For Telstra on November 28 2017.

This stock is not covered in-house by Ord Minnett. Instead, the broker whitelabels research by JP Morgan.

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