EUR 850.00 For Business Accounts Only

Morningstar | Investors Connect with Telstra as External Interferences Abate. See Updated Analyst Note from 18 Jul 2019

Shares in Telstra are still at a 13% discount to our unchanged AUD 4.40 fair value estimate, despite rallying 38% since the start of 2019 (inclusive of dividend). The market finally appears willing to price in some turnaround potential in the narrow-moat-rated group, in stark contrast to a year ago when scepticism reigned supreme. It may also be a case of the tail wagging the dog, with the rising stock price feeding investors the sense that Telstra's intrinsic value is somehow improving.

Internally, little has changed in a fundamental sense. Job-shedding, digitisation and simplification efforts are progressing faster than expected, bringing forward AUD 200 million in restructuring charges to fiscal 2019 (for a total of AUD 800 million) and AUD 500 million in noncash legacy IT asset writedowns. But such timing changes have no impact on our intrinsic assessment which already assumes successful execution of the 8,000 job cuts and AUD 2.5 billion net cost-out plan by the end of fiscal 2022.

Externally, industry headwinds are abating. In mobile, competition especially from Optus is reducing, and Telstra has explicitly telegraphed to both Optus and Vodafone its rejuvenated intent to retain/win customers and fortify its 49% subscriber share. Fixed-line broadband is as competitive as ever, but Telstra's market share is holding tight (at just below 50%). In other segments such as corporate and legacy fixed-line units, conditions remain challenging but that is why management is stepping up the cost-out drive. While the government is still dithering on whether/how to restructure the much-maligned NBN, Telstra is quietly establishing a first-mover advantage in 5G mobile, aided by uncertainties hampering Vodafone and its merger plans with TPG Telecom. This 5G first-mover advantage will become increasingly important, not only for competitive reasons, but as a serious long-term alternative for consumers to bypass the NBN's byzantine fixed-line delivery infrastructure.

Perhaps these external factors mostly explain the recent rally in Telstra shares, further helped by its relative yield appeal (currently at 4.2% fully franked) against a backdrop of falling interest rates. Ultimately, we expect benefits of both Telstra's internal transformation/cost-cutting program and external industry developments to result in a resumption of underlying earnings growth from fiscal 2023 where we expect EBITDA to be up 6% from fiscal 2022. Certainly, very few of these benefits will be evident in the upcoming fiscal 2019 result, with our forecast EBITDA at AUD 9.0 billion, down 11% year on year and in the middle of management guidance of AUD 8.7 to 9.4 billion.

Circling back to Telstra's all-encompassing transformation program, there will be further AUD 350 million in restructuring expenses beyond fiscal 2019. That will amount to a total of AUD 1.4 billion in restructuring costs under the program to eliminate 8,000 jobs, designed to lop AUD 2.5 billion from the cost base. Much of this restructuring is a direct consequence of the NBN taking over Telstra's traditional wholesale network infrastructure, rendering many positions redundant. In addition, efforts to digitise and simplify the plodding behemoth that is Telstra will naturally result in employee reduction. That is, for instance, the whole point of the company cutting its mobile and broadband connectivity plans from 1,800 to just 20, an initiative that will take a couple of years as legacy plans come up for renewal and existing customers migrate. It is a belated rationalisation that not only makes it simpler for customers (who can personalise their offerings with extra add-ons according to their preferences), but also reduce Telstra's labour intensity.

Finally, on the competitive landscape in the all-important mobile space (40% of group earnings), Optus' aggression has been easing for the past three to four months, in terms of subsidies on mobile plans. Having kickstarted the discounting last year and forcing Telstra to follow suit, Australia's number-two mobile player appears more at ease given TPG Telecom's abandoned mobile ambitions and the merger/regulatory distractions ailing TPG Telecom and Vodafone. And just as well for Optus, given the task ahead in upgrading to 5G mobile where it is already behind Telstra.