FYI | Feb 05 2007
By Chris Shaw
While Telstra (TLS) has enjoyed renewed support of late the same cannot be said for Telecom New Zealand (TEL, TCN.NZ) as the company continues to struggle operationally and must now find a replacement for its CEO, Theresa Gattung, who announced her resignation with the quarterly profit result last week.
Gattung’s resignation is an issue for the company, as while JP Morgan suggests new management is necessary given the breakdown in communications between the company and the government Merrill Lynch takes the view a new CEO could look to follow Telstra’s lead and implement a transformation program. The broker suggests such an outcome would likely put pressure on short-term earnings.
It is earnings that remain the real story, as the company’s quarterly profit of NZ$192m was below the market’s expectations of NZ$204m and was seen as a poor quality one by both ABN Amro and Merrills. Following the result earnings expectations across the market have been revised down by roughly 1-4% for FY07.
ABN Amro points to the Australian operations as a major area of concern as there is no evidence of any turnaround. Merrill Lynch agrees, noting current Australian earnings guidance of $40m in EBITDA terms appears overly optimistic as it implies a massive 2H turnaround. As a result, the broker suggests there is still some downside risk to the market’s newly revised forecasts.
These forecasts are based on company guidance of a full year profit result of NZ$810-830m, which compares to previous guidance of NZ$820-860m. At the same time, likely capital expenditure requirements have been increased, adding weight to the Merrills view of further downside risk.
Not surprisingly then, the bias in terms of broker ratings is at the negative end of the scale as the FNArena database shows the stock as rated as Buy once, Hold four times and Sell/Reduce four times.
The Buy rating comes from JP Morgan, which sees potential for the company to announce some capital management initiative when it completes the proposed sale of its directories business.
The broker expects competition for the asset to result in a price at the upper end of the current valuation range of NZ$1.6-$2.2bn, with a significant portion of the proceeds likely to be used to buyback shares or in a capital reduction. On its numbers, a NZ$1.6bn buyback would be 8-9% earnings accretive by FY09.
While ABN Amro rates the stock as Sell it estimates there is NZ10-20c upside to its valuation of NZ$4.25 from the sale of the directories operations or the acquisition of Powertel (PWT), for which the company has announced a bid.
Not everyone is convinced such a positive capital management outcome is possible, as Credit Suisse argues the likelihood of higher capital expenditure in Australia reduces the amount that could be returned from the sale of the directories operations.
Merrill Lynch agrees and suggests the likely sale is already in the share price at current levels, while GSJB Were sees the market as being overly optimistic on the sale outcome while not giving due attention to the risks the company faces from its challenging earnings targets in Australia and the changing regulatory environment in New Zealand.
Taking this into consideration, Credit Suisse suggests investors switch in Telstra at current levels as there is as much as 10% upside to the Australian company’s consensus estimates in FY08 from operating cost savings and labour force restructuring.
Price targets for the stock vary widely from ABN Amro’s NZ$4.25 to JP Morgan’s NZ$5.25, Credit Suisse being somewhat in the middle at NZ$4.85. By way of comparison, Thomson One Analytics notes the median price target on the stock is NZ$4.75.
Shares in Telecom are slightly weaker in today’s trading, as at 12.30pm the stock was down 3c at $4.26, which equates to about NZ$4.82 per share. The stock has fallen from levels of around A$4.50 at the end of January.