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Vocus Making Progress

Australia | Feb 28 2019

Telco Vocus Group is making progress with its turnaround, prioritising profitable growth in enterprise, government and wholesale markets in Australasia, although it still faces myriad challenges.

-NBN not considered sustainable or economic in the consumer market
-Morgans suggests returns need to more than double to justify the capital deployed
-Intention to double enterprise, government and wholesale revenue within five years


By Eva Brocklehurst

It is early days, but brokers welcome the performance of Vocus Group ((VOC)) in the first half, with revenue improving and the Australia-Singapore cable (ASC) being completed and launched. That project is likely to come in under budget by -$10m, Macquarie calculates, because of good project management and favourable FX hedging.

The broker was also pleased with an improved sales performance in network services, although this was somewhat offset by higher churn.The Optus MVNO deal was renegotiated, providing Vocus with the ability to participate in the wireless broadband and mobile market. Vocus expects to double its networks revenue over the next five years and will provide more quantifiable targets as an investor briefing in May.

Commander (business) revenue lagged the rest of the business in the first half, falling -27%, with declines attributed to higher customer churn and the roll off of legacy NBN revenue. The company also stated the NBN is not economic or sustainable in the consumer market.

Instead, Vocus aims to maximise profitable growth within core enterprise, government and wholesale (EGW) markets in Australasia and double revenue from these divisions within five years.

New guidance on cost savings and reductions in capital expenditure have been taken seriously by the market, and Ord Minnett believes this dealt with what is likely to be the last of the short covering in the shares.

While building in the $30m in network cost savings and $30m in reduced capital expenditure targets that were announced, the broker believes it will still be hard for the company to double EGW revenue in five years time.

Deutsche Bank points out the strong cash flow conversion of 98% and welcomes the clarity on the growth plans. Still, this is the first result in a multi-year turnaround and the broker is concerned this market may have traded ahead of successful completion.

3-year Outlook

UBS is impressed by the calibre of management and believes the strategy to grow earnings on a three-year view is coherent. The company intends to win share in a corporate market that is seeking alternatives to incumbents, while stemming consumer and Commander headwinds by strategic initiatives such as the Optus partnership.

Morgans considers the return on capital metrics sub-optimal and these need to more than double to justify the capital deployed. The broker believes the catalyst which will restore investor interest is for new management to prove it can get on top of the hurdles as well as integrate acquisitions to stabilise earnings.

The main concern relates to debt on the balance sheet, although this is likely to improve amid higher free cash flow going forward. Morgans believes capital is best spent on de-gearing the business.

UBS notes, looking into FY20, incremental earnings contributors could include a normalisation of share-based payments and a full 12 months contribution from ASC. Still, even if FY20 operating earnings lifted to $400m, the broker considers the stock would be expensive.

Guidance for operating earnings (EBITDA) of $350-370m has been maintained for FY19. This is critical to Morgan Stanley's view, as implies a return to positive operating earnings growth of 6% in the second half and should set a sustainable base for FY20.

Yet Macquarie points out the company needs to pick up momentum in the second half in order to achieve guidance. The broker looks for improved trends within network solutions, while ASC revenues should build up and assist earnings.

Division Outlook

Citi observes good progress with the turnaround, although the company still faces challenges in the Commander and consumer divisions. Longer term, the broker envisages potential from EGW. However, revenue growth has slowed in that division because of higher churn associated with legacy contracts.

EGW already contributes 61% of group operating earnings. Meanwhile, Citi assesses the goal is managing the decline in consumer and Commander revenues rather than attempting long-term earnings growth. While there is some pricing pressure, the company does not expect margins in the EGW segment to move materially.

Credit Suisse now expects an uplift in operating earnings by almost 50% between FY18 and FY23, noting there could be further upside if the company's target is achieved.

In the consumer division, challenging NBN economics mean the company has moved away from growing it share and instead will focus on optimising the experience for existing customers.

As a result Ord Minnett lowers NBN subscriber edition forecast significantly reducing net additions to 50-60,000 over FY19-21 from 100-120,000. This, in turn, reduces consumer revenue estimates by -$54m in FY19, -$116m in FY20 and -$176m in FY21. However, margins are expected to increase slightly as the company adds more profitable subscribers.

FNArena's database shows one Buy (Morgan Stanley), five Hold and two Sell ratings. The consensus target is $3.64, suggesting -0.7% downside to the last share price. Targets range from $3.10 (UBS) to $4.25 (Ord Minnett).

NB: the author has shares in the company.

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