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Morningstar | Soft Customer Growth Hits Millicom’s 2Q as Acquisitions and Integration Remain in Focus

Millicom posted soft second-quarter results, with normalized group revenue growing 1.7% year over year, the slowest pace in nearly two years. Management pointed to last year’s World Cup and a large commercial contract in Colombia as the primary reasons behind the slowdown, but we also found customer growth in Colombia, Guatemala, and Bolivia--among the firm’s most important markets--somewhat disappointing. Competition also continues to weigh on Paraguay and El Salvador. Despite near-term challenges, we still believe Millicom holds solid long-term potential as it brings wireless and fixed-line networks together across its service territory and the benefits of Telefonica exiting Central America materialize. We don’t anticipate any significant changes to our $86 per ADR fair value estimate or narrow moat rating; we believe shares are attractive.

Millicom’s operation in Colombia, its largest revenue contributor, took a small step back. After a long stretch of stiff competition, revenue returned to growth (in local currency) last quarter on strong wireless customer additions. However, the firm added only 103,000 customers during the second quarter, better than a year ago but down sharply sequentially. Local revenue was down 0.2% year over year and likely would have been roughly flat excluding the one-time commercial contract revenue a year ago. By contrast, market leader America Movil earlier reported accelerating customer additions and a strong increase in revenue per customer during the quarter.

In Guatemala, wireless customer growth rebounded following a net loss during the prior quarter, but cable customer growth, which has been torrid recently, ground to a halt. Revenue growth in the country was still solid, however. We still expect the Guatemalan market will produce solid long-term results, with rational competition following consolidation in the wireless market down to two players. The EBITDA margin in the country also remains above 50%.

Management continues to call out particularly stiff competition in Paraguay and El Salvador. In Paraguay, customer growth has remained solid, but revenue declined modestly for the second consecutive quarter and margins have tumbled about 3 percentage points versus a year ago. Millicom claims that it is investing in marketing and promotions to defend market share, and it remains the largest player in the market. In El Salvador, customer metrics continue to stabilize, but the impact of sharp customer losses in late 2017 and much of 2018 continue to pull revenue and margins lower. Competition in the country should ease as Telefonica exits and the market consolidates.

Millicom completed the acquisition of Telefonica’s operations in Nicaragua and the sale of its business in Chad during the quarter. Group net debt increased to $6.3 billion from $5.0 billion at the end of 2018, or about 2.8 times EBITDA from around 2.3 times. Closing the Telefonica transaction in Costa Rica and Panama will add another $1 billion in debt, leaving leverage around 3.0 times. We expect Millicom’s growth rate will increase as acquisitions are integrated and its focus in Central and South America bears fruit. This growth, coupled with steady debt repayment, should enable leverage to near management’s long-term target of 2.0 times over the next three years.