NBN Delay Largely Neutral For Telstra

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

NBN Co will cease activating the HFC component of its broadband roll-out for 6-9 months in order to improve the service quality of current connections. Brokers suggest Telstra has a natural hedge in the near term, earning income from those still connected via traditional means.

-Pushes out around $500m in one-off payments to Telstra to FY19/20 from FY18
-Delay less significant given HFC network is in metro areas
-New dividend policy could be stretched in order to pay 22c per share
 

By Eva Brocklehurst

A decision by the NBN Co to delay the rolling out of connections by 6-9 months has meant Telstra ((TLS)) is reviewing its earnings guidance, with a new outlook for FY18 to be provided shortly.

The delay to the rolling out of HFC (hybrid fibre coaxial) is because of service problems, with NBN Co intent on improving the performance before making more connections. This will push around 330,000 connections due in FY18 into FY19/20. HFC allows high-speed broadband content to be delivered to the home using a combination of fibre and coaxial cable.

A "natural hedge" as brokers describe it, will come into play for Telstra, pushing around $500m of one-of payments it was due to receive from NBN out to FY19/20 from FY18, which Credit Suisse calculates is $300m net of the cost to connect.

Brokers expect Telstra will generate higher operating earnings (EBITDA) in FY18/19 as a result, as it will take longer for customers to be transferred to the NBN. Over the two-three-year period Credit Suisse estimates $100m in additional earnings because of the delay.

This will smooth out the earnings profile for Telstra, extending payments into the later years and delaying the impact of transition. Credit Suisse raises FY19 estimates for earnings per share (EPS) by 3.4% and FY20 by 4.3%. FY18 is reduced by -2.4%.

Citi estimates, if the delay lasts for the full nine months, this could potentially mean EPS is cut by around -3% for both FY18 and FY19, with corresponding upgrades to the later years. According to the NBN business plan, as much is one third of all new activations over FY18 and FY19 are supposed to be delivered over HFC.

Macquarie envisages only a small impact in FY18 to recurring earnings, with the benefits from legacy access earnings and lower NBN wholesale input costs offset by lower NBN commercial works revenue and earnings. Hence, from a valuation perspective, the broker considers the impact benign.

The corresponding boost to margin which comes with the delay will be less significant given that the HFC network is entirely in metro areas, where the company's retail market share is much lower. The benefit of an NBN delay would be much more significant, Citi points out, it was to affect regional areas.

Citi maintains a Sell rating and anticipates possible reductions to earnings per share estimates of -3% in FY18 when Telstra provides its new statement on the outlook.

Dividends

The broker believes Telstra will now need to stretch its new dividend policy to the limit in order to pay $0.22 in FY18. The company's plan is to pay out 70-9% of core earnings as well as 75% of the net one-of NBN payments over the roll-out. While there is enough flexibility to maintain dividend payments, the delay suggests an increased risk Telstra will need to borrow more to pay special dividends in advance of the funds being received from NBN.

On the flipside, stronger earnings for longer on the copper network will be maintained. Citi maintains a Sell rating and anticipates possible reductions to EPS estimates of -3% in FY18 when Telstra provides its new statement on the outlook.

The delay has no of impact on Credit Suisse forecasts for the dividend. The broker believes the stock offers fundamental value at current levels and the dividend is sustainable. A return to growth in mobile is expected, despite near-term competitive pressures and Credit Suisse maintains an Outperform rating.

Despite a potential hit to FY18, UBS envisages scope for the company to lift the pay-out on the one-off components of earnings in order to maintain the $0.22 dividend. Longer-term, NBN Co has assumed it will catch up in activations, such that 8m premises are still expected to be connected by 2020. Therefore the earnings profile for Telstra should be broadly unchanged.

The broker notes responsibility for remediating the networks falls to NBN Co, in return for which Telstra will begin paying NBN Co pre-determined remediation credits.

Macquarie does not expect Telstra's capacity to pay a $0.22 dividend will be affected. The broker maintains a Neutral rating, noting that while valuation is appealing enough at current levels, the company continues to face a challenging competitive environment.

FNArena's database shows three Buy, three Hold and two Sell ratings. The consensus target is $3.79, suggesting 11.1% upside to the last share price. Targets range from $3.40 (Morgan Stanley, yet to comment on the news) to $4.15 (Morgans, yet to comment on the news). The dividend yield on both FY18 and FY19 forecasts is 6.5%.
 

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