Another telco adjusts to structural shift in the sector

Morningstar's fair value estimate for this price-leading telco has been revised down 15 per cent, as Australian players gird their operations while the National Broadband Network roll-out ramps up.

This week's TPG Telecom (ASX: TPM) annual general meeting reiterated management's previous earnings before interest, taxes, depreciation and amortisation (EBITDA) outlook for fiscal 2017, but concerns about the revenue effect of NBN have increased.

As a result, Morningstar's fair value estimate has been dropped to $8.50 per share, down from $10. This brings it in line with competitor Vocus Communications (ASX: VOC), which also recently saw a reduction in fair value, albeit a more modest drop of 5 per cent.

"The higher NBN access costs [of around $40 per month per subscriber] could reduce TPG's EBITDA base by up to 25 per cent when the NBN is largely rolled out by the end of fiscal 2020," says Brian Han, senior equity analyst, Morningstar.

TPG is particularly vulnerable on this front, with almost 70 per cent of its broadband subscribers currently using the company's own infrastructure--meaning it pays access costs of between $13 and $18 per month per subscriber.

While this has been a significant positive for the business, the levelling effect of the NBN, which will see all Australian telcos switch to the NBN's fibre infrastructure, will erode much of TPG's existing price advantage.

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In addition to reducing its fair value estimate, Morningstar has also upgraded the fair value uncertainty rating on the company to high, from medium.

"It is time to recognise the fundamental change the NBN will inflict," says Han, despite the mitigating effects of "snaring a greater share of the regional broadband market ... and continuing growth in the corporate market."

In addition to a greater focus on its regional broadband and corporate channels to help offset tightening margins due to the NBN, TPG has also announced plans to expand into Singapore's mobile telephony market.

"We are ambivalent, to say the least, about this venture ... while we are hesitant to underestimate TPG, the Singaporean mobile market appears to be a whole different competitive landscape than when TPG first entered Australia, when broadband was still at an embryonic stage," says Han.

On the upside, he emphasises Morningstar's long-term assumptions of 10.5 per cent revenue growth for TPG's consumer broadband division, and 8 per cent corporate division revenue growth.

TPG also retains its narrow moat rating, which remains stable for at least the medium term, though Han suggests this may change as the full roll-out of the NBN draws closer in the next two or more years.

Overall, he believes the company "is well positioned for the impending structural change in the domestic telecommunications industry".

This hinges largely on the roll-out of the NBN further boosting consumer take-up of high-traffic products such as internet protocol television, which will in turn increase demand for broadband.

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Glenn Freeman is Morningstar's senior editor.

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