Company Reports

We view Telstra's 3% increase in fiscal 2024's first-half underlying EBITDA to AUD 4.02 billion positively.

Telstra's performance during and since the depth of COVID-19 demonstrates the resilience of its earnings and the strength of its balance sheet, especially given the negative impact on high-margin roaming revenue was material during the pandemic. The AUD 2.7 billion cost-out program under T22 has been delivered and management is now focused on hitting the AUD 500 million cost reduction target under the T25 plan.

Shares in Telstra are trading at an attractive 16% discount to our AUD 4.50 fair value estimate. The underperformance since the fiscal 2023 results release in August, down 9% versus a 4% decline in the ASX 200 Accumulation Index, likely reflects lingering investor misgivings on the tardy progress toward T25 targets and the kyboshing of InfraCo-Fixed monetization.

Telstra's performance during the depth of COVID-19 demonstrates the resilience of its earnings and the strength of its balance sheet, especially given the negative impact on high-margin roaming revenue was material. The AUD 2.7 billion cost-out program under T22 has been delivered and management is now focused on hitting the AUD 500 million cost reduction target under the T25 plan.

The preliminary impact of COVID-19 on Telstra demonstrates the relative resilience of its earnings and the comfort of its balance sheet, although the impact on high-margin roaming revenue and delays to the productivity program are notable.

Efficient scale typically applies to firms that serve a market of limited size, in which potential competitors have little incentive to enter because doing so would lower the industry’s returns below the cost of capital. Although we observe efficient scale across nearly every sector, it is most common in highly regulated and capital-intensive industries, such as regulated utilities, telecom services, midstream oil and gas, REITs, and railroads.

We put our fair value estimate for Telstra under review.

Telstra released fiscal 2014 earnings, reporting underlying net profit after tax, or NPAT, of AUD 4 billion, in line with our forecasts. Underlying earnings before interest, tax, depreciation and amortisation, or EBITDA, rose 3% to AUD 10.7 billion, slightly ahead of our AUD 10.6 billion estimate. Confirmation of an AUD 1 billion off-market share buyback was a key positive takeaway.

Telstra is the leading telecommunications and information service provider in Australia. It has either dominant or significant market share in each service category and is the lowest-cost provider, underpinning its narrow moat rating. While competition is robust, mobile market shares are likely to prove reasonably resilient. The industry is highly regulated and the extent of regulation can penalise Telstra due to its market position and historical ownership.

Ahead of a management briefing in late May, which will focus solely on Telstra Corporation's mobile business, we outline recent pricing trends and our market share expectations for the division. Broadly, we believe the competitive environment in the retail mobile market is improving. For almost 12 months there appears to have been a gradual reduction in handset subsidies by all three network operators. Although carriers have been broadly increasing data allowances on post-paid plans, voice pricing has been relatively stable, even increasing in some lower-value segments. Although we note that exact charges are difficult to compare given changes to headline price points. On a stand-alone basis, we expect plan and subsidy adjustment to be positive for Telstra mobile margins, although a full earnings period benefit may not emerge for 12 to 24 months.

Telstra is the leading telecommunications and information service provider in Australia. It has either dominant or significant market share in each service category and is the lowest-cost provider, underpinning its narrow moat rating. While competition is robust, mobile market shares are likely to prove reasonably resilient. The industry is highly regulated and the extent of regulation can penalise Telstra due to its market position and historical ownership.

Telstra is the leading telecommunications and information service provider in Australia. It has either dominant or significant market share in each service category and is the lowest-cost provider, underpinning its narrow moat rating. While competition is robust, mobile market shares are likely to prove reasonably resilient. The industry is highly regulated and the extent of regulation can penalise Telstra due to its market position and historical ownership.

Telstra released its first half fiscal 2014 results, reporting net profit after tax of AUD 1.74 billion – in line with our AUD 1.75 billion forecast. At an operational level there were small beats in mobile and fixed broadband, supported by better-than-expected subscriber growth and solid trends in average revenue per user, or ARPU. This was offset by lower-than-expected growth in network applications and services, or NAS, where margins were impacted by upfront costs associated with new contracts. For example, the new AUD 1.1 billion Department of Defence contract which commenced in the second half of fiscal 2013. Growth in NAS was still impressive, revenue was up 29% against the prior period.

Telstra has signed a non-binding memorandum of understanding with Telkom Indonesia to create a joint venture, or JV, that will provide network services in Indonesia. The proposed JV will be the exclusive provider of network application and services, or NAS, in Indonesia for both companies. Although in isolation this is a relatively small event for Telstra, the deal highlights one of the ways Telstra can deliver on its Asian growth strategy. Partnership with local players could provide Telstra a lower-risk alternative to acquisitions, which are also likely to form part of the expansion strategy. That said, these partnerships are "slow-burn" opportunities that are unlikely to deliver a material earnings contribution in the short to medium term.

Narrow-moat rated Telstra has agreed to sell a 70% stake in some of the assets of Sensis, its directories and advertising business. The directories and mapping operations of Sensis are the key assets included in the sale. Telstra will realise AUD 454 million from the sale, implying a total value for the assets of AUD 649 million. This implies a fiscal 2014 earnings multiple based on earnings before interest, tax, depreciation and amortisation, or EBITDA, of about 2.4 times. We believe this is a fair outcome given the ongoing structural decline and earnings deterioration within Sensis. Divestment will further strengthen the Telstra balance sheet and provides management with additional capacity to return cash to shareholders. We reiterate our view that a material increase in the dividend may be unlikely given limited excess franking credits.

Telstra is the leading telecommunications and information service provider in Australia. It has either dominant or significant market share in each service category and is the lowest-cost provider, underpinning its narrow moat rating. While competition is robust, mobile market shares are likely to prove reasonably resilient. The industry is highly regulated and the extent of regulation can penalise Telstra due to its market position and historical ownership.

Narrow-moat rated Telstra has agreed to sell its majority stake in CSL, the Hong Kong based mobile business. Telstra owns 76.4% of CSL with New World Development holding the remaining 23.6%. CSL will be sold to HKT Limited for USD 2.425 billion. This implies sale proceeds for Telstra of approximately AUD 2 billion. The transaction is subject to regulatory approval in Hong Kong as well as HKT and PCCW shareholder approval. Management anticipates completion of the sale around the end of the first quarter in calendar 2014.

Telstra is the leading telecommunications and information service provider in Australia. It has either dominant or significant market share in each service category and is the lowest-cost provider, underpinning its narrow moat rating. While competition is robust, mobile market shares are likely to prove reasonably resilient. The industry is highly regulated and the extent of regulation can penalise Telstra due to its market position and historical ownership.

Telstra's Investor Day reaffirms our view the company is positioned well for the convergence between telecommunications, technology, and digital media in Australia. The company has also realigned its senior leadership to place a greater focus on new growth businesses in Network, Applications and Services and its operations in Asia. Trends toward mobile connectivity, increasing demand for bandwidth, and network dependency play into the hands of Telstra's competitive advantage in superior network quality. With recent investment in its 4G network and spectrum, we expect Telstra to maintain its competitive advantage going forward. This reinforces Telstra's ability to maintain market share in mobile and fixed broadband in both the consumer and corporate segment. The firm's scale and ownership means it is the lowest-cost provider, and underpins our narrow economic moat rating. Our thesis remains intact, and we continue to expect mobile, network, applications and services and digital media to offset declining revenue from fixed products. Our fair value estimate of AUD 4.30 per share, and our forecast, are also unchanged.

Narrow-moat Telstra's annual general meeting provided no surprises with fiscal 2014 earnings guidance reaffirmed. Earnings before interest, tax depreciation and amortisation is expected to grow in the low-single digits with free cash flow remaining robust at between AUD 4.6 billion and AUD 5.1 billion. There were also no new updates on capital management initiations and dividend guidance given the proposed changes to the national broadband network, or NBN, and the respective compensation payments. We leave our earnings estimates unchanged and our fair value is maintained at AUD 4.30. We also maintain our fiscal 2014 and fiscal 2015 dividend forecast of AUD 30 cents per share and AUD 31 cents per share respectively, which we believe are supported by the strong free cash flow.