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Morningstar | Telefonica Deutschland Reported Better 2018 Results, but Provided Weak Guidance; Lowering Our FVE

Telefonica Deutschland reported 2018 results that were ahead of our expectations. However, management’s comments regarding additional margin expansion potential are less than we expected. Thus, despite better 2018 results, we expect to reduce our fair value estimate to EUR 4 per share from EUR 4.50. We continue to believe the company has no moat, but even with the lower fair value estimate, the shares are undervalued. That said, we would prefer to own Telefonica, its parent company’s stock.

Telefonica Deutschland reported revenue growth of 3.2% year over year in the fourth quarter, which pushed its full-year revenue to a gain of 0.3% versus our expectation of a decline of 1%. However, the main boost to revenue was a 25.2% jump in handset revenue, which we don’t believe is sustainable. The firm’s wireless service revenue declined 0.4% for the year as its wireless subscriber base declined 0.8% to 42.8 million, as losses in prepaid customers more than offset postpaid gains. However, those prepaid customers that left were hardly using their phones, so average revenue per user, or ARPU, in prepaid actually increased 11.4% to EUR 5.9 per month, while postpaid ARPU fell 4% to EUR 14.9. We expect these trends will likely continue in 2019.

The fixed-line revenue fell 11% for both the quarter and the year. However, we expect the decline to slow going forward as Telefonica Deutschland grew its fixed-line subscriber base in the fourth quarter due to broadband customer growth. That said, broadband subscribers generate lower ARPU than traditional fixed-line customers.

The firm did a solid job of controlling costs during the year, generating an adjusted EBITDA margin of 25.7% versus our projection of 25.5%. However, management stated it has achieved 90% of the cost savings from the merger with E-Plus. We had anticipated larger future cost savings. While it announced a new cost savings program, this likely won’t be sufficient to reach our previous EBITDA margin projections.