The National Broadband Network (NBN) has changed the competitive landscape dramatically within the telecommunication sector. By June 2017 the NBN will account for 30 per cent of all household fixed line internet connections, which makes the implications hard to ignore going forward. Telstra has been progressively releasing the implications to its earnings and details of how it is looking to replace the earnings gap created by the NBN. Effectively Telstra will lose circa 30pc of its earnings before interest, tax, depreciation and amortisation (EBITDA), but is taking steps to limit this to around a 7pc (or circa $770m) loss, assuming everything goes to plan.
We also need to point out that Telstra gets one-off compensation to the tune of $4bn from the government after paying for one-off items like restructures and cost to connect to the NBN. This extra capital can be used to replace this missing 7pc via building out existing earnings streams, buying more earnings streams and/or buying back its own shares. We do expect Telstra will emerge in a strong position post 2020 and believe that the dividend is maintainable but it’s going to be a messy few years to get there.
The above scenario is based on the following key assumptions:
- We assume Telstra has 50pc NBN market share (broadly similar to current levels). This equates to 4.1m subscribers for which Telstra pays $43 per customer per month to the NBN in access costs.
- We assume Telstra loses half of its $2.6m wholesale EBITDA (since 52pc of Telstra’s wholesale subscribers are fixed subscribers and many of these customers will buy directly off NBN rather than Telstra).
- NBN payments to Telstra will reach circa $1bn per annum as NBN rents ducts and other infrastructure off Telstra to put their NBN cables in.
- Telstra is aiming to remove $1bn in operating costs by 2020 as it simplifies the business and no longer has to support the last mile of copper.
- Telstra has flagged an additional A$1bn per annum of capex over the next three years and it expects this additional capex will generate around $500m in additional EBITDA (from new revenue and business improvements).
- Telstra has invested less than $1bn in new businesses (including Telstra Health, Telstra Software Group and Telstra Ventures), which cost Telstra $172m in 2017. It expects these businesses to reach EBITDA breakeven by 2020, which means they will no longer have a negative impact on EBITDA. It won’t be an easy task, but Telstra has a solid plan to restructure and reposition the business for a post NBN world. This, combined with deploying the A$4bn in one-off capital, should mean Telstra’s dividend is sustainable in a post NBN world.
Investment view – hold recommendation, A$4.50 valuation
In the short term we think the share price risk lies to the downside for Telstra, as we remain relatively cautious based on current expectations heading into the August full year result and capital management.
In the long term however, we see upside risk (assuming our view is correct and the NBN is forced to rebase its last mile access costs). We do not expect a dividend cut but highlight this is a risk heading into the full year result in August and could occur depending on the Board’s view of earnings post NBN.
- Justin Still, Investment Adviser (Authorised Representative: 000279726) Morgans Financial Limited | ABN 49 010 669 726 | AFSL 235410
