Telcos: Focus On Mobile Revenue Growth

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-2014 more about earnings, not yield
-Focus on deploying cash flow
-Mobile revenue growth to star
 

By Eva Brocklehurst

The underlying theme in the telecommunications sector in 2014 is the National Broadband Network roll out. This has a slightly slower trajectory than brokers originally thought to be the case. They suspect this has little effect on Telstra's ((TLS)) valuation, while it is marginally positive for the other major players on the network, TPG Telecom ((TPM)) and iiNet ((IIN)).

NBN Co is proposing a mix of technologies which includes some of the former federal government's Fibre-To-The-Premises (FTTP) plan with the bulk being the current government's favoured Fibre-To-The-Node (FTTN). This should provide some continuity and momentum, according to Goldman Sachs, but there's still uncertainty as the industry addresses additional reviews, corporate plans and organisational issues.

The sector outperformed in 2013 amid a search for yield and defensive earnings growth. This year, with the stocks trading at the upper end of historical ranges, Goldman believes performance will largely be about tweaking earnings growth forecasts. Small telcos are not expected to feature in mergers and acquisitions this year, as the companies seek to integrate acquisitions and deploy cash flow to reduce debt.

The upcoming earnings period should reveal strong mobile growth for Telstra, in JP Morgan's opinion. The broker will be interested in whether margins are being also ratcheted higher. JP Morgan expects consumer fixed business margins to ease slightly. The balance sheet should attract attention following recent asset sales but JP Morgan does not expect a capital management initiative, or the raising of dividends this time around. Goldman thinks there'll be an increasing focus on whether a dividend increase is on the way but suspects the company may seek to neutralise potential for earnings dilution by using the proceeds of assets sales for debt reduction and/or buy-backs. Still the broker has punted on ordinary dividends rising to 30c by FY15 and FY16 against prior forecasts of 28c (FY13 actual), reflecting a more stable earnings outlook and moving in line with the consensus view on the FNArena database.

It's been three years since the last shake-out in mobile pricing and Citi wonders whether such stability can last. The broker thinks the same can be said for fixed line broadcasting. It appears the telecoms operators have moved away from pricing as a way to stimulate market share gain. For mobile operators, and Telstra in particular, it's the network quality and coverage that's become the selling point. Nevertheless, the roll out of 4G networks could reduce this advantage and drive a return to pricing strategies. In fixed line broadband, as the market has matured, Citi thinks customer bases have become stickier and operators are focusing on value bundling.

Goldman Sachs expects mobile revenue to be the highlight of the results season, with a return to growth in 2014 because of record capex last year and 4G data monetisation. The take up of 4G has driven increased data usage. While there's no specific numbers, Goldman Sachs estimates 4G smartphone usage is twice that of 3G. The broker notes both Telstra and Optus have driven 4G penetration to 20% and Vodafone to 17%. The broker expects pricing competition to remain rational in 2014 although the record network investment last year is seen manifesting in greater competition this year.

Telstra is expected to come up against more competition in metro areas as Optus [Singtel ((SGT))] and Vodafone [Hutchison Telecom ((HTA))] leverage near-term spectrum advantages. Fixed broadband growth is expected to stay robust but Goldman thinks uncertainty on the NBN front, in terms of both re-negotiations and roll-out, will prevail. The broker thinks Telstra is well paced to protect the value of its NBN deal but there is a threat inherent in what TPG may do with the Fibre-To-The-Basement (FTTB). That company's FTTB plan marks a step up in the competition on infrastructure and Goldman does expect there'll be some competitive response from Telstra and/or Optus. Still, the broker is of the opinion the plans should help TPG to drive market share gains.

Goldman Sachs has downgraded TPG to Sell on valuation, suspecting that the company is not factoring in all the competitive and execution risks. Expected market share gains are also overly optimistic. The stock had a strong run since September and looks to be over priced, in both Goldman and JP Morgan's view. JP Morgan is hoping for more detail on the benefits of the AAPT acquisition and the FTTB project at the results briefing.

The brokers have reduced expectations for earnings growth from iiNet. JP Morgan believes the company is struggling to obtain organic growth. The broker wants to see just how well iiNet has integrated the acquisitions of the last few years and whether earnings expectations from the integration have been met. JP Morgan also has issues with the valuation in terms of the long-term re-basing of returns in the NBN arena, suspecting it may be difficult for these to become sustainable. Goldman is more optimistic and still expects earnings to grow organically this year, noting the company has a first mover advantage that places it in a good position to capitalise on the growing opportunity in the NBN.
 

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