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Morningstar | Maintaining Telia’s SEK 40 FVE After Finalizing Model, Despite Weak Q4 Results; Shares Fairly Valued

Telia reported fourth-quarter revenue and EBITDA margin below our expectations but did generate strong free cash flow. While the weakness is concerning, we are maintaining our SEK 40 fair value estimate after reviewing our model. Our narrow moat rating is intact, and we believe the shares are fairly valued. The firm reported revenue grew 4.9% year over year in the quarter, but this was all currency driven. On an organic basis, revenue declined 2.9%. This caused full-year revenue growth of 4.7% to fall well short of our 7.3% projection.

Most of the revenue shortfall came from weak fixed-line telephone results in Sweden, Denmark, and Lithuania. In Sweden, which accounts for about 44% of the firm’s revenue, revenue fell 3.3% in the quarter. While mobile revenue increased 1.1%, fixed-line revenue dropped 3.8%, which was more than we anticipated. Tele2 recently acquired Com Hem, the largest cable TV operator in the country, creating a strong convergent competitor. Thus, we expect the fixed-line business will continue to struggle.

Telia’s cost-cutting had been ahead running ahead of our expectations but fell back in the fourth quarter. While the firm only generated an adjusted EBITDA margin of 30.3% for the quarter and 31.9% for the year versus our projection of 32.9%, we anticipate that the cost-cutting will continue. We expect the firm can reach an EBITDA margin of about 34% in 2023. Additionally, the company succeeded in increasing its free cash flow from continuing operations to SEK 1.4 billion in the quarter and SEK 10.8 billion for the year versus its objective of SEK 9.7 billion. Management expects free cash flow to increase by about another 10% in 2019. We believe this higher free cash flow signals that revenue growth and margin expansion will continue. In 2019, Telia will benefit from its two recent acquisitions in Norway that make it a converged operator. Thus, while the quarter was weak, we remain positive on Telia’s long-term fundamental story.

As for the fixed-line business, Denmark is a smaller country with low margins, so we are less concerned about its weak fixed-line business. We are more concerned with Lithuania as it has generated strong revenue growth for the past four years. However, the wireless business remained strong with revenue growth of 16.3%, but the fixed-line business fell enough to more than offset the wireless growth, taking organic revenue down 2.6%. While we no longer expect much revenue growth from Lithuania, we believe the firm as a whole can increase revenue slightly going forward.

During the fourth quarter, Telia succeeded in selling its stakes in Ucell in Uzbekistan and Kcell in Kazakhstan. With these transactions complete, the firm has successfully exited from most of its Eurasian assets. Management should now be able to fully focus on running the business.