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Brokers Cautious About Telstra’s Strategy

Australia | Jun 21 2018

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

Telstra has downwardly revised FY19 earnings expectations significantly, and brokers increasingly believe dividends will be cut from FY19.

-Near-term positive catalysts are limited unless Telstra can demonstrate earnings will hit a trough in FY19
-Next 12 months considered most intense for competition as NBN migrations reach a peak
-Lower earnings likely to translate into lower dividends regardless of NBN delays

 

By Eva Brocklehurst

Telstra ((TLS)) has outlined a major restructuring program comprising simplification, asset sales and a potential de-merger of its infrastructure. In the short term, assumed delays in the NBN payments and competitive pressure, particularly in mobiles, mean earnings expectations for FY19 have been lowered significantly.

Guidance for operating earnings (EBITDA) is $8.7-9.4bn which includes $1.8-1.9bn in net NBN one-off payments. This is well below broker estimates. Capital management policy is unchanged and no guidance on dividends was offered. To fund its revenue “hole” Telstra has lifted its targeted fixed cost reductions to $2.5bn, from $1.5bn, by FY22.

Telstra will monetise up to $2bn in assets over the next 24 months to support the balance sheet, given the lower near-term earnings outlook. More specific announcements will be made at the August results. Macquarie points out Foxtel and property assets have been flagged for divestment in the past.

In theory, UBS suggests the announcements should lift terminal earnings per share, versus a "do nothing" scenario, and even lift FY22 EBIT back above that of FY19.

The issue is execution and the share price reaction suggests the market is sceptical and not crediting the company for the cost reductions and 5G monetisation that is expected beyond FY20.

Near-term catalysts are limited, unless Telstra can demonstrate underlying earnings have hit a trough in FY19 and the broker suspects Telstra has two broader ambitions that were only subtly signalled at the strategy briefing.

The first is an intention to aggressively defend its market share by provisioning for a high single-digit earnings decline and drawing a line in the sand against competitors. UBS believes Telstra has more in its arsenal in terms of cost reductions, NBN payments and dividend reductions to offset declines in industry cash flow relative to competitors.

The second is where the company has explicitly confirmed fixed wireless will be the most significant early use of 5G. Telstra believes 25-30% of the market can be addressed by fixed wireless and UBS calculates this adds around 3c to long-term earnings per share.

Morgans agrees some positive catalysts are required to rebuild confidence and reinvigorate investor interest yet, overall, the changes will place the company in a better position to improve its business in the medium term.

The broker's outlook is based on a low valuation and the probability that the NBN is forced to lower last-mile access prices. The next 12 months are considered likely to be the most intense for competition, ergo pessimism surrounding Telstra, as NBN migrations reach a peak.

Citi reduces estimates for earnings per share by -33-36% for FY19-20 and allows for a full $2.5bn in productivity gains in FY22 forecasts. Yet, the broker is sceptical about the company's ability to deliver on its increased productivity target and remains convinced that the market expectations around the dividend are too high.

The broker now forecasts mobile revenue to fall by -16% and operating earnings to reduce to $3.0bn over the next four years, suggesting most of this decline reflects the normalisation of competition for a three-player market, with TPG Telecom ((TPM)) only having a small impact compared with current trends.

Infrastructure

Citi believes there is potential upside from an infrastructure company but this would have been significantly higher if the mobile network was included.

The company's intention is to create a stand-alone infrastructure unit with $11bn of assets, $5.5bn of revenue and $3bn of operating earnings. This would comprise fixed infrastructure assets as well as NBN commercial works and Telstra wholesale.

UBS does not believe the optical split of an infrastructure company will drive material upside in the short term ,as it will merely be a change in reporting structure. Longer term the structure could perhaps have a strategic value if NBN is sold back to private operators.

Ord Minnett is more positive following the negative share price reaction and estimates the shares are now trading at fair value based on the expected dividend yield. The broker believes a structural separation will eventually be done and could yield more than 20% upside on the current proposal.

The company has flagged the potential de-merger, or entry of a strategic investor, after the NBN roll-out. This vehicle, if de-merged, could then be in a position to take part in any privatisation of NBN Co down the track, Macquarie suggests.

Mobiles

The broker remains concerned about the revenue trajectory into FY19 and the pressure on the mobiles business. The strategy will mean Telstra regains initiative in the market but cost and risks remain.

Telstra is moving to new plan structures that remove a number of extra charges such as excess data from its mobiles. This will eliminate up to $500m in revenue over three years. The company intends to consolidate its consumer/SMB plans to 20 from the current number over 1800.

Dividend

Ord Minnett now expects the FY19-20 dividend to be reduced to $0.18, and $0.15 from FY21, representing a 6.5% and 5.5% yield respectively. Macquarie envisages dividends will be cut to $0.16 per share from FY19 to reflect the lower earnings. UBS factors in $0.16 and $0.14 for FY19 and FY20 respectively.

Morgans interprets the company's silence on dividend policy to suggest that lower earnings will translate into lower dividends regardless of NBN timing delays.

The broker points out that the board could alter the current policy to factor in a higher pay-out ratio or one-off NBN payments, or include proceeds from asset sales. Yet, given the uncertainty, does not factor this into assumptions. Morgans reduces FY19-20 dividend estimates to $0.17 per share.

FNArena's database shows five Buy ratings, one Hold (Macquarie) and two Sell. The consensus target is $3.20, suggesting 16.0% upside to the last share price. Targets range from $2.30 (Citi) to $3.95 (Credit Suisse, yet to comment on the briefing). The dividend yield on FY18 and FY19 forecasts is 7.9% and 6.8% respectively.

See also, Is Another Dividend Cut Looming For Telstra? on May 15, 2018.

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.

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