Telstra’s 1H20 financial results were broadly in line with expectations and FY20 guidance was re-affirmed. The result was overshadowed by the Federal Court’s decision to allow the proposed merger of Vodafone and TPG to proceed. On face value, a 3-player mobile market should be more rational and profitable than a 4-player mobile market and there are various pieces of research that support this notion. But the quality of the players matters too. In this case, a combined TPG/Vodafone may be perceived as a stronger telco competitor than the alternative of staying as separate sub-scale entities. It then depends on whether TPG/Vodafone decide to compete aggressively on price to win market share.
This is a strategy that has been tried by other players in the market and has not been particularly successful as competitors have shown a propensity to react by discounting as well.
Telstra has a multi-brand strategy with its price-fighter brand Belong positioned to compete against Vodafone, so the potential impact of greater competitive intensity from TPG/Vodafone is likely to be felt more by Optus.
Telstra moving forward while others stand still
The other issue to consider is that while the merger approval process has been grinding its way through the ACCC and Federal court for the past 18 months, TPG and Vodafone have been unable to move forward with their strategic agenda. Telstra and other players have likely benefited from this distraction, so there will be some normalisation over the course of the year with TPG/Vodafone indicating they are working towards merger completion by mid-2020.
It is also worth noting that the ACCC has 28 days to appeal the Federal Court’s decision. If an appeal is lodged, there will be another lengthy delay to the merger outcome, which would be incrementally positive for Telstra.
While the merger will consume the market’s focus in the short term, there are several reasons to be positive on Telstra’s longer term prospects.
Telstra reported that underlying EBITDA (earnings before interest, tax, depreciation & amortisation) excluding the in-year nbn headwind grew by approximately $90m – the first time there has been growth since FY16. This shows that the T22 strategy is delivering positive momentum.
The performance of the Mobile division is stabilising with EBITDA falling $47m vs. the previous comparable period, after declining $342m in FY19 and $274m in FY18. Subscriber additions were ahead of expectations. Mobile is a critical driver of the Telstra investment case given it accounts for nearly 50% of underlying EBITDA. Forward-looking indicators are positive with postpaid transacting MMC (minimum monthly commitment) increasing $2-3 across the Consumer and Small Business division, which will drive a moderation in ARPU (average revenue per user) declines in 2H20.
Telstra’s Network Applications & Services division performed well with margins returning to mid-teens at 15.7% on lower costs and improved product mix. Global Connectivity achieved a 34% increase in EBITDA due to a greater focus on profitable products. On the negative side, the Fixed and Data & IP divisions declined, although this was largely to be expected.
Telstra continues to deliver against its $2.5bn net productivity target, having now achieved a $1.6bn net reduction in underlying fixed costs since 2016. This is necessary to offset the NBN headwind, which is expected to peak in FY21.
We expect 5G to be a key tailwind over the coming years
Telstra and other industry participants have specifically called out their desire to monetise 5G by providing more differentiated service offerings. This should support revenue growth in the industry which has been absent for some time.
Overall, Telstra’s results showed their T22 strategy is gaining momentum with the mobile division stabilising and the cost reduction program well underway. If Telstra can continue to hit their guidance and demonstrate a return to growth in Mobile division earnings, the stock should continue to re-rate, although this is contingent on the competitive environment remaining rational.
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