article 3 months old

Eroding Margins Still Critical For TPG Telecom

Australia | Mar 21 2018

TPG Telecom has boosted FY18 guidance, partly because of the delay in transfer to the NBN. Yet brokers remain keenly aware of the margin risks.

-Offsetting margin erosion from NBN migration remains critical
-Could bypass NBN over time but requires substantial spectrum
-May need to be more aggressive with consumer pricing and customer acquisition

 

By Eva Brocklehurst

Fierce competition prevails for TPG Telecom ((TPM)), which has seen broadband subscribers decline for the first time. Brokers were pleased with the first half results but voiced concerns regarding the soft consumer segment.

The company has boosted FY18 guidance by 2.5%, partly because of the delay in the transfer to the NBN. FY18 operating earnings (EBITDA) are now expected between $825-830m. TPG Telecom has an improved outlook for NBN margins, stemming from the resilience of average revenue per unit, lower CVC charges and a shift to NBN50 plans.

Yet the margin erosion that will come from the migration to the NBN and the ability to offset this through cost reductions remains the critical issue for the company. UBS warns that the NBN migration lag is not a permanent benefit, while upgrading estimates for FY18 and FY19 operating earnings by 2.5% and 1.5% respectively, ex mobile.

The temporary NBN delay, and reduced overheads, may boost current earnings at the expense of future profits but, given the poor margin outlook for the NBN, this is the right choice in Citi's view, because it will help to fund a mobile network.

Morgans believes TPG has done a commendable job to reduce costs and simplify its acquired businesses. iiNet is a predominantly a consumer-facing business with high customer advocacy, so the broker believes TPG needs to tread carefully in respect of integration and cost reductions. CLSA is expecting more synergies from iiNet and improved margins, because of a shift to higher-end products.

Credit Suisse suggests net profit in FY19 will be significantly affected by the timing of the start up of TPG mobile services in Australia and the requirement to start amortising spectrum and depreciating the capital investment.

The broker does foresee an opportunity for TPG to use its mobile network to bypass the NBN over time, but visibility on the upside is limited and any bypass strategy would require substantial amounts of additional spectrum.

Mobile

The company remains fully committed to its Singapore and Australian mobile expansion. This, Morgans believes, is the meaningful medium-term upside opportunity. The company intends to secure a mobile roaming deal although no details are forthcoming at this stage.

Excluding the debt drawn for capital expenditure on mobile, the broker believes the stock is attractive, although this does depend on the success of the mobile venture.

UBS suspects there could be further capital expenditure that has not been factored into current guidance. The company could possibly purchase spectrum in the 3.6 GHz auction and will also need to consider rolling out a 5G mobile network. The broker estimates, if it needs to purchase spectrum or invest in 5G before FY20, there is only around $650m available.

CLSA believes mobile will be de-risked through a roaming deal and next-generation network architecture, suggesting the risk of an equity raising is lower because the company will have more than $1bn in head room for potential investment in 5G. CLSA, not one of the eight stockbrokers monitored daily on the FNArena database, has an Outperform rating and $6.85 target.

Current capital expenditure plans are manageable, but Citi suggests the balance sheet could be stretched and, if spectrum auctions are highly competitive, TPG will have to raise more capital. The broker believes the stock will be a more attractive investment once the bulk of the mobile capital expenditure has passed through.

Subscribers

Broadband subscribers fell by -8,000 in the first half. Management has indicated that subscriber trends have improved a little since the NBN50 plans were launched late last year but Macquarie believes sustainability is dependent on competition going forward. If pressures persist, the company may need to be more aggressive with pricing or customer acquisition strategies.

Credit Suisse calculates the company's iiNet market share was down to 24.3% at the end of 2017 and the decline reflects ongoing competition to capture broadband subscribers as the NBN rolls out. Moreover, competition in the price sensitive segment is particularly intense.

Citi agrees TPG could deliver the better subscriber growth outcome with a larger marketing campaign but this would not be a good use of funds at present. The broker expects cutting back on marketing in order to fund mobile capital expenditure will prove to be a positive in the long run.

Management remains upbeat about the rolling out of fibre in Adelaide. The company will build a fibre network capable of 10 gigabytes per second over 1000 sites and the footprint will enable around 3,500 businesses to access the infrastructure.

FNArena's database shows one Buy rating (Morgan Stanley), three Hold and four Sell. The consensus target is $5.68, suggesting -5.3% downside to the last share price. Targets range from $4.55 (Credit Suisse) to $7.00 (Morgan Stanley).

Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" – Warning this story contains unashamedly positive feedback on the service provided.

Share on FacebookTweet about this on TwitterShare on LinkedIn

Click to view our Glossary of Financial Terms