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Investors connect with Telstra as restructure advances

Lex Hall  |  23 Jul 2019Text size  Decrease  Increase  |  
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The industry headwinds facing Telstra (ASX: TLS) are abating and it is on track to resume earnings growth and cement its lead across all segments, says Morningstar’s Brian Han.

Australia’s major telco is in the midst of a transformation program, cutting jobs and streamlining its operations as it seeks to ward off competition and build its capabilities in 5G.

And the market sees the turnaround potential building. Telstra’s share price has gained 38 per cent this year, a far cry from a year ago when, as Han puts it, “scepticism” about its future “reigned supreme.”

However, he notes, “it may also be a case of the tail wagging the dog, with the rising stock price feeding investors the sense that Telstra’s intrinsic value is somehow improving.”

The narrow-moat-rated group is currently trading at a 13 per cent discount to Han’s fair value estimate of $4.40. Telstra’s dividend payout ratio stands at 4.2 per cent fully franked, down from a lofty 6.3 per cent in 2017, but nevertheless attractive in a low-yield climate.

Bracing for the NBN

The key issue facing investors is how management aims to plug the $3 billion earnings hole that will be inflicted by the National Broadband Network.

But Han is confident the telco’s transformation is progressing faster than expected. The slow-moving behemoth is taking practical steps to streamline its network and maintain its market-share lead across fixed voice, broadband, mobile services and the corporate/enterprise market.

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Key to this is the transformation program. As part of this, Telstra is shedding 8000 jobs, a move that is designed to cut $2.5 billion from its cost base.

It has also cut its mobile and connectivity plans from 1800 to 20 – a move that will take a couple of years, according to Han, as legacy plans come up for renewal.

The reason for this wholesale restructure and the wave of the redundancies is the result of the NBN taking over Telstra’s traditional wholesale network, not to mention the digitisation push to make the company more efficient.

The NBN rollout will result in the gradual decommissioning and transfer of customers to the NBN.

But Telstra will receive compensation and maintenance and capital expenditure will fall sharply. This will improve cash flow and support dividend payouts.

“Compensation payments amount to an after-tax net present value of $11 billion,” says Han. “These payments should help underpin current dividends.”

CEO Andy Penn, who replaced David Thodey in 2015, copped flak for this cut but Han believes it is necessary to give the company financial and operational flexibility amid heightened competition and industry change.

The transformation program is forecast to boost earnings, but it will take a few years to kick in. Fiscal earnings in 2023 are forecast to exceed 2022 by 6 per cent.

For now the 2019 fiscal result will show few of the benefits, Han warns. His forecast EBITDA is $9 billion, down 11 per cent year on year – and in the mid-range of management’s indication of $8.7 billion to $9.4 billion.


Telstra at a glance

  • Fair value estimate of $4.40
  • Generates about 40 per cent of group operating earnings from the mobile. Mobile market share 48pc – up from 40pc in 2011
  • Fixed-line broadband: 50pc share of subscribers
  • Establishing first-mover advantage in 5G mobile
  • NBN, once rolled out, could curb Telstra annual earnings by $3 billion
  • Regulatory risks: cut in fixed broadband wholesale prices and government decision on mobile roaming could force Telstra to open up its network to other operators in regional areas



is senior editor for Morningstar Australia

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