Company Overview: Telstra Corporation Limited (Telstra) is a telecommunications and technology company. Its principal activity is to provide telecommunications and information services for domestic and international customers. The Company operates through four segments. The Telstra Retail segment provides telecommunication products, services and solutions across mobiles, fixed and mobile broadband, telephony and Pay television/Internet Protocol television and digital content. The Global Enterprise and Services segment provides sales and contract management for business and government customers. The Telstra Operations segment offers overall planning, design, engineering and architecture and construction of Telstra networks, technology and information technology solution. The Telstra Wholesale segment provides a range of telecommunication products and services delivered over Telstra networks and associated support systems to other carriers, carriage service providers and Internet service providers.


TLS Details
Reaffirming confidence on dividend payment: Down 28.5% in last one year (as at January 05, 2018), embattled telecom player Telstra (ASX: TLS) seems to be resurging with a 10.4% rise in last three months and is estimated to trade at 12.8x PE with a return on equity better than the sector median and its peers. The group had revised its financial year 2018 guidance at the back of the impact of nbn co.’s announcement to cease sale on HFC (hybrid fibre co-axial) technology for a period of six to nine months from December 2017, and in relation to nbn’s Corporate Plan for 2018. However, the group retained its operating outlook guidance and reaffirmed the 2018 dividend, which is an important aspect to note from the perspective that the group is still confident to provide returns to shareholders as promised post the dividend slash highlighted in 2017. While the nbn shortcomings led to reduction in number of brownfields that would be ready for service, and respective activations in 2018, TLS outlook initially sat comfortably within the guidance range provided in August 2017, but is now tweaked post the latest delays. Owing to this, the revenue recognition for Telstra commercial work contracts with the nbn has been delayed. While the work is not delayed, cash flow impact has been flagged to be lower than the earnings impact. In addition, the key thing to note is that the nbn rollout delays have been anticipated to have a modestly positive financial effect on Telstra over the full rollout owing to the effects of the natural hedge which continues to exist. This whole scenario has helped the group stick to its 2018 dividend without any further slashes.
 

Revised Guidance (Source: Company Reports)
 
Going back a bit, Australia’s telecommunication market has been fundamentally altered by the rollout of the nbn network and customer migrations were seen reaching peak volumes. Under the definite agreements signed with nbn co and the Government, TLS was said to receive payments that were identified to partially compensate it from the nbn rollout. Recently, it was observed that due to the significant costs associated with the roll out of the nbn, the wholesale broadband prices in Australia from nbn increased by almost 100 per cent in the migration and were slated to even lead to an increase in the cost by 20 to 25 per cent over the next three-to-four years under the nbn plans. Meanwhile, TLS had offered funds to its 42,000 customers on nbn plans who paid for the ‘speed boosts’ which could not be achieved on their service. As per the commercial requirements on nbn from the government, it needs to make $52 per end user on its network which leaves a little room for Telstra to make much profits as most of the Australians have not shown any interest to pay more than $60 per month for the broadband.
 
Financial Performance: Telstra demonstrated a decent FY17 performance as the total income got increased by 4.3 per cent to $28.2 billion and EBIDTA increased by 2 per cent to $10.7 billion. The Board also announced a fully franked final dividend of 15.5 cents per share which brought the total dividend for the financial year to 31.0 cents per share and buy-back got completed during the year owing to which TLS returned $5.2 billion to the shareholders. It reduced its underlying fixed cost by $244 million and this was consistent as announced in 2016. The group intends to accelerate its efforts to reduce the costs further over the next five years by bringing forward its $1 billion net productivity target by one year to FY20. It also has increased its target of a further cost saving of $500 million. Its media revenue has increased by 8.2 per cent to $935 million due to strong performance of Foxtel. Net cash by operating activities declined by 4.4 per cent which included Autohome net earnings of $120 million in the prior year and restructuring costs of $304 million. Current liabilities decreased by 0.3 per cent to $9,159 million.
 

Value Drivers (Source: Company Reports)
 
Customer Value Performance: Its highest priority is improving its customer experience and it had recovered its Net Promoter Score in the second half of the financial year 2017. It has made a good progress and the customer growth continued across the key segments with retail mobile net adds of 218,000 including 169,000 post-paid handheld net adds and 132,000 domestic retail fixed broadband customers. nbn connections also grew from 6,76,000 to 1,176,000 which brought total market share to 52 per cent. Almost 90 per cent of its retail fixed broadband customers are now on a bundle with growth of 224,000 and this includes the “Best Bundle Ever” and the “Hottest Entertainment Bundle”.
 
Capital Allocation Strategy: TLS had adopted a new capital allocation strategy outlaying a revised capital management framework focussed on maintaining tight fiscal discipline and had maximised its return to the shareholders last year. It maintained its financial strength and retained its financial flexibility for investment in future. Telstra also adopted a new dividend policy which closely aligned its ordinary dividends to its underlying earnings. It had tried its best to maintain its balance sheet settings which are consistent with A band credit rating.
 
Outlook for 2018: TLS had earlier expected that its income will be in the range of $28.3 to $30.2 billion and EBIDTA to be in the range of $10.7 to $11.2 billion. This has been revised as mentioned above while capital expenditure is expected to be still between $4.4-$4.8 billion or approximately 18 per cent capex to sales. It expects a total dividend of 22 cents per share which will be fully-franked and includes both ordinary and special dividends. The rollout of the nbn network will continue to accelerate, fundamentally, which will alter the Australian telecommunications’ landscape. Meanwhile, TLS had planned an additional investment of up to $3 billion over FY17-19 and will also direct more than $1.5 billion to build the networks for the future, approximately $1 billion which will enhance the digitisation of its business. Some structural changes were also highlighted to take effect soon and included Telstra Retail to be renamed as Telstra Consumer & Small business, Global Enterprise and Services to be renamed as Telstra Enterprise while Telstra Ventures will move to Technology, Innovation and Strategy.
 

Growth Opportunities (Source: Company Reports)
 
Expansion in terms of Operations: Telstra has also indicated its new businesses to include Telstra Health which has moved from an acquisition phase to an integration phase with a focus on new solutions with its existing assets. After acquiring Pacnet, TLS has increased its customer base. It continued to invest in China to strengthen its presence in the country. In Indonesia, one of its joint venture, telkomtelstra with PTT Telekomunikasi Indonesia is proving to be very successful as it delivered unique and high-quality solutions and services for 150 customer projects and also managed in excess of 10,000 Network Service sites. TLS’ subsidiary Ooyala, revised its strategy including restructuring of its global software and services organisation. Recently, TLS also welcomed the Australian Competition and Consumer Commission’s favourable decision to clear the combination of Foxtel and Fox Sports into a new company while it remains subject to certain conditions.
 
Stock Recommendation: TLS seems to breakout to a better potential this year. With management’s impact assessment of nbn’s recent changes and compensation receipts to Telstra just reducing in the near term but expected to make up in the future; revised guidance only attributable to the impact of the nbn delays while underlying operating outlook is maintained and dividend outlook stays sustainable; and incremental positive impact from nbn’s changes to its wholesale pricing from 2Q 2018, TLS can replace a good part of earnings hole from nbn. We believe that the stock that has seen volatility in 2017, and now trades at reasonable forward earnings per share, is a “Buy” at the current price of $3.75


TLS Daily Chart (Source: Thomson Reuters)

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