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Morningstar | Singing the Same Chorus on Earnings but a Different Tune on Earnings Multiple. See Updated Analyst Note from 25 Feb 2019

Chorus' fiscal 2019 first-half result was devoid of any surprises, with the 3% (NZD 11 million) decline in EBITDA to NZD 318 million in line with our expectations. As such, we make no changes to our earnings estimates, with our fiscal 2019 EBITDA of NZD 638 million within management's reiterated guidance range of NZD 625 million-645 million. Our fair value estimate for the no-moat-rated group edges up 2% to NZD 4.10 per share, adjusted for time value of money.

The group's earnings profile remains dependent on offsetting the revenue impact of legacy copper connection losses, with gains from broadband connection growth. This offset did not quite match in the first half, as the NZD 43 million combined uplift from fibre-related revenue to NZD 173 million was more than wiped out by the aggregate NZD 55 million decline in copper-related sales to NZD 247 million. In total, group revenue fell 2%, or NZD 10 million, to NZD 489 million.

This is the very reason for the elevated focus on micro cost management, most evident in the 6% fall in head count and reduced network maintenance expenditures. It kept Chorus' cost base largely flat NZD 171 million, buffering the impact of negative operating leverage from the NZD 10 million revenue slippage compared with a year ago.

Still, it is not earnings that is driving Chorus' share price (up more than 40% over the past year) but investors' willingness to pay up for those relatively resilient earnings. Indeed, the stock is trading at a 27% premium to our fair value estimate. The regulatory picture governing the company's fibre network economics is slowly taking shape, helping to rerate Chorus' enterprise value/EBITDA to 8, up from 6 only a year ago. However, exploitation of the arbitrage upside from treating Chorus as a higher-multiple utility business (as opposed to a much-maligned, lower-multiple telecom business) appears premature, especially as vital details on the fibre regulatory framework from 2020 are still scarce.

The group ended the December half with net debt of NZD 2.4 billion, equating to net debt/EBITDA of 3.8. This is up from 3.4 six months ago, driven by capital expenditures on the continuing fibre network rollout, but still well under the 4.75 covenant limit. The board declared an interim dividend per share of NZD 0.095, fully imputed. This was in line with our expectations, as is management's reiterated full-year DPS of NZD 0.23.

In terms of connection trends, Chorus lost 40,000 total fixed lines in the six months ended December 2018. This was mostly copper-only lines, which fell 38,000, broadly in line with the losses suffered in each of the previous two halves. In broadband connections, Chorus lost 1,000 lines, as 18,000 gains in Chorus' ultra-fast broadband areas were mostly offset by 18,000 line losses in local fibre company markets (an additional 1,000 lines were lost in rural, non-ultra-fast broadband areas).

Finally, fibre connections show no signs of slowing, surpassing the 500,000 mark during the half and equating to a fibre take-up rate of 51%. The upcoming rugby World Cup in September could be another catalyst to accelerate fibre take-up. The broadcast rights holder Spark will leverage the event to boost mobile customers who will be able to stream all games on their handsets. However, it is more likely to increase awareness of, and demand for, fibre, especially considering the challenges faced by Optus' mobile customers with the football World Cup last year in Australia.