Australia | Sep 20 2017
The outlook has dimmed for TPG Telecom as it battles to offset margin pressures from the NBN by aggressively rolling out its mobile network.
-Dividend cut in FY17; assumptions for none or little out to FY20
-Subscriber growth continues to slow despite aggressive mobile offering
-Capital outlay heading substantially higher
By Eva Brocklehurst
The outlook has dimmed substantially for TPG Telecom ((TPM)) as it battles to offset margin pressures from the NBN by aggressively rolling out its mobile network. Dividend payments were lower than expected in FY17 and the company has flagged a doubling of capital expenditure versus operating cash flow in FY18.
Capex will become substantially higher in the next few years as the mobile business in Australia and Singapore is built. Yet subscriber growth continues to slow, despite an aggressive mobile offering launched in March as a Vodafone re-seller.
Morgan Stanley envisages TPG as a stock presenting investors with higher risk but also higher potential returns, as the company is a disruptor in the consumer and corporate broadband market and soon to be so in mobile. The broker acknowledges the challenges from NBN-related margin pressures and competition but envisages a value opportunity in mobile investment which is under-rated by the market.
Morgan Stanley finds the reaffirmation of mobile capital expenditure and timing constructive, as well as the new bank lines for funding and a cut to the dividends. This all makes strategic and financial sense in the broker's view and an Overweight rating is maintained.
Mobile Transition
Citi agrees a transition to mobile requires a leap of faith and there are likely to be three years of negative cash flow, as the company builds up mobile networks at the same time that the migration to NBN compresses broadband margins. Revenue from these mobile networks is unlikely to flow prior to FY20. This suggests to the broker there is too much uncertainty over the level of future earnings.
Citi estimates the rising cost of NBN access will cut the company's consumer earnings by around -$200m over the next three years, with fixed voice also disappearing completely in that time. The broker expects consumer operating earnings to reach a low point of $306m in FY21.
The relationship between more attractively priced plans and subscriber growth appears to be weakening, Morgans suggests, as the company struggles to convert mobile payments into mobile subscriber growth. In the broker's opinion this illustrates that consumers are not just worried about getting the lowest price.
Credit Suisse also cites the drop-off in subscriber growth as a key concern ahead of the mobile network roll-out. The broker envisages the mobile strategy is high risk and retains an Underperform rating.
Deutsche Bank suggests the stock could offer longer term appeal if management is able to deliver on the Australian and Singapore mobile plans. Nonetheless, the stock faces earnings declines and a low dividend pay-out ratio as capital is conserved and the broker downgrades to Hold from Buy.
FY18 guidance is for underlying operating earnings (EBITDA) to decline -2-4% to $800-815m. Morgans believes this is a solid outcome, considering the substantial pressures on NBN margins. Credit Suisse forecasts net profit to fall -45% in FY19 as full mobile start-up costs and depreciation come through. The broker estimates market share was down to 24.9% of the end of FY17 versus 25.4% at the end of FY16.
FTTB (fibre-to-the-basement) net additions were also disappointing for the broker, at 13,000 in the second half. Macquarie notes the company appears to have slowed its rolling out of FTTB, given concerns about the regulatory environment. The company will apply to the ACCC to improve its functional separation of wholesale activities once legislation is enacted.
Dividends, Capital Outlay
The reduction in the dividend and the increase in the debt ceiling have helped alleviate concerns about another capital raising but Ord Minnett finds no positive catalysts over the next 6-12 months. The broker assumes the dividend will be completely eliminated over FY18-20 and could be reinstated in FY21, as the Australian and Singapore mobile businesses start to generate earnings.
Macquarie believes value will come from executing on mobile strategies and suggests there is some positive progress being made. While no guidance has been provided on forward pay-outs, the broker's FY18 dividend estimates are re-set to 4c per share, held until the end of the Australian roll-out. Any return to a higher dividend would, in the broker's opinion, signal management's increased confidence that the mobiles strategy is delivering.
Accounting Treatment
Management has changed segment disclosures and removes iiNet as a stand-alone segment, consolidating its result into the corporate and consumer segments. The company is also revising guidance for the treatment of spectrum amortisation which will now begin when the mobile network is ready for its intended use rather than from when the spectrum is available.
Morgans upgrades FY18 forecasts earnings per share by 10% but this is a function of the new accounting treatment, which capitalises a large portion of the company's mobile expenditure. In the broker's opinion the main upside and downside risk relates to the ability to deliver free cash flow and service increasing debt.
Macquarie observes business-as-usual capital expenditure will remain high in FY18, with guidance of $270-310m, including expenditure on the last part of the Vodafone network roll-out. On the positive side, management has indicated it is progressing discussions for mobile site access in Australia. TPG expects to have clusters of sites ready for service in Sydney, Melbourne and Canberra by mid-2018.
FNArena's database shows one Buy rating (Morgan Stanley), four Hold and three Sell. The consensus target is $5.62, suggesting 7.9% upside to the last share price. This compares with $6.51 ahead of the results. Targets range from $4.30 (Morgans) to $7.00 (Morgan Stanley).
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