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Morningstar | Telefonica Deutschland Reported Mixed 1Q Results with Better Revenue Growth but Weaker Margins

Telefonica Deutschland reported mixed first-quarter results with better revenue growth but lower EBITDA margins. However, these were both primarily driven by strong sales of low-margin handsets, so we don’t anticipate any significant changes to our EUR 4 per share fair value estimate. We continue to believe the company has no moat and the stock is undervalued.

Reported revenue grew 0.7% year over year versus our full-year projection of a 0.6% decline. However, this gain was almost all due to a 12.6% jump in handset revenue. Wireless service revenue declined 0.5%. While the firm added 306,000 postpaid wireless subscribers in the quarter, taking its total base to 22.6 million, its average revenue per user, or ARPU, fell 3.8% to EUR 14.20. The reverse occurred on the prepaid side, where Telefonica lost 211,000 customers, taking its base down to 20.3 million, but its ARPU improved 3.3% to EUR 5.70. Importantly, data revenue grew 4.1%. We expect continued data revenue growth will lead to higher postpaid ARPU and allow the firm to generate consistent wireless revenue growth.

However, the fixed-line telephone side remains a problem, with revenue falling 8.6% as it relies on wholesaling capacity from Deutsche Telekom. That said, we believe Vodafone’s announcement on May 7 that it will wholesale capacity from its much faster broadband network to Telefonica if regulators approve Vodafone’s purchase of Unitymedia from Liberty Global is a positive. If this deal is consummated, we would expect Telefonica to be able to improve its fixed-line performance, as it could offer broadband speeds that are much faster than Deutsche Telekom can offer and thus distinguish its service.

Telefonica’s greater handset sales pressured its EBITDA margin, as handsets generate minimal margin. Thus, the firm reported an adjusted EBITDA margin before leases of 23% versus our full-year projection of 26.1%. However, the first quarter also generates the seasonally lowest margin of the year. Importantly, the firm's EBITDA margin was still higher than the year ago period, so we think our projection is reachable.