Australia | Mar 23 2016
-More iiNet synergies likely
-NBN margin pressure
-Cost reductions continue
By Eva Brocklehurst
TPG Telecom ((TPM)) has signalled its recent acquisition of iiNet is following in the footsteps of the successful integration of AAPT, with first half results better than most brokers expected and providing upside potential.
Morgans was impressed with TPG's 31% underlying earnings growth. Revenue from iiNet declined and gross margins held steady at around 44%, so the broker observes an earnings beat in that regard (iiNet earnings were up 30%) was primarily because of cost cutting, as the company takes its cost conscious approach to its new assets to extract greater value.
The broker suspects the cost line in the half-year numbers included a number of one-off redundancies and assumes the underlying cost base could be lower still. Net customer additions were lower than Morgans expected for TPG and higher than expected for iiNet, confounding suspicions that iiNet customers jumped ship after the takeover.
The broker concludes that both are broadly holding market share in the NBN (national broadband network) relative to their national average. Meanwhile, mobile continued to go backwards, with earnings declining 26% as the company works through moving customers to Vodafone from the Optus network.
Morgans previously assumed margin pressure would be more severe under the NBN but now expects TPG to pull sufficient costs out of iiNet in the medium term to offset this, at least partially. Earnings margins are forecast to stabilise at 25%. The ability to offset margin erosion from the NBN remains the key risk either way for the stock, the broker maintains.
Ord Minnett also considers the key risk to its call is higher synergies from iiNet. Forecasts are upgraded to account for this as TPG has also provided guidance for the first time for FY16 earnings, between $770-775m. The broker acknowledges that given the company's strong cost culture, there may be upside to its estimates.
Consumer broadband additions moderated and Macquarie believes NBN margin pressures are starting to show in this segment, largely as NBN and bundled ADSL were the fastest growing categories. The broker expects TPG to focus on market share, on-net products and corporate growth as offsets.
Once fibre-to-the-building (FTTB) assets are working as a functional separate unit, this should allow the company to offer these products via the TPG and iiNet brands, alongside other carriers wanting to buy wholesale access, and this could further increase the take up of the services.
Macquarie notes the TPG corporate segment now delivers a larger earnings contribution than the consumer segment, although this becomes smaller again once the iiNet contribution is included. Still, continued strong growth is expected from corporates as the company takes share from larger incumbent operators and benefits from the roll-out of the Vodafone network.
The broker notes mobile subscriber losses were high, reflecting competition in the BYOD (bring your own device) market and the migration of users to Vodafone. BYOD refers to employees bringing their own devices, such as smart phones, to the workplace for use on the secure corporate networks.
Goldman Sachs also revises up estimates to reflect a higher contribution from iiNet in FY16-17. The broker attributes part of the slowdown in consumer broadband additions to a shift in a portion of its base to the FTTB offering.
Credit Suisse also found subscriber growth below its expectations. The broker calculates TPG/iiNet accounted for 14% of total broadband additions in the half, below its 26% overall market share, which implies some loss of market share.
TPG needs to grow its share substantially, the broker contends, in order to offset the costs from the NBN and this may not be easy in an increasingly competitive environment. Credit Suisse does not believe the headwinds are priced into the current share price, retaining an Underperform rating.
Morgan Stanley expects the company's broadband margin will decline to 30% in the long-term from the current 40%, but not to the 20% the market currently expects. The broker has little doubt the retail broadband margin will fall as the NBN rolls out but believes the market is too bearish on this segment
Morgan Stanley estimates the company generates an earnings margin of 27% on NBN plans and believes the company's lean operating cost structure is a sustainable competitive advantage.
FNArena's database shows one Buy rating (Morgan Stanley), three Hold and one Sell (Credit Suisse). The consensus target is $10.52, suggesting 6.1% downside to the last share price. Targets range from $9.00 (Credit Suisse) to $11.40 (Morgan Stanley).
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