EUR 850.00 For Business Accounts Only

Morningstar | O2D Updated Forecasts and Estimates from 17 Aug 2018

Telefonica Deutschland reported better-than-expected second-quarter EBITDA margins. However, we were already projecting significant margin expansion over the next several years, so we are maintaining our EUR 4.50 per share fair value estimate and no-moat rating. Despite an 8% price increase in response to the results, we believe the stock is still slightly undervalued.

The firm reported that revenue fell 0.7% year over year versus our full-year projection of a 0.5% decline. Wireless revenue grew 0.8% driven by handset sales, which jumped 8.5%. Handset sales are low-margin, which makes the EBITDA margin performance all the more impressive. However, we are a bit concerned that wireless service revenue declined 0.5% as its wireless subscriber base fell 4.9% to 43 million. Importantly, though, its more profitable customers grew, including 4.4% in its postpaid base and 15.1% in its LTE base. Its smartphone penetration improved 6%, to 63.5%. These gains should continue to enhance its average revenue per user, which already improved 3% to EUR 10.

As expected, the fixed-line business continues to rapidly decline as Telefonica winds down its fixed-line wholesale business. In total, fixed-line revenue fell 11.8%. However, its fixed-line retail business is showing signs of stabilization, dropping only 0.4%.

The key to our investment thesis on Telefonica Deutschland has been cost cutting from the acquisition of E-Plus leading to margin improvement. We have previously been disappointed at the slow progress being made with margin expansion. However, this quarter shows the potential that we’ve been projecting, so we are very excited to see the margin gains.