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Morningstar | Telstra Competing Hard and Shedding Excess Weight to Do So. See Updated Analyst Note from 13 Feb 2019

The importance of the 239,000 increase in Telstra post-paid mobile subscribers in the December-half cannot be overemphasised. Granted, the cost of this gain was felt in the 2% fall in post-paid average revenue per user, or ARPU, and manifested in the 6% decline in fiscal 2019 first-half mobile EBITDA to AUD 1,905 million. However, these outcomes for the narrow-moat group's most important division (41% of group normalised EBITDA) were still moderately above expectations. Critically, increasing subscribers provides an importance base for monetisation and establishing first-mover advantage, as Telstra transitions to 5G.

To offset the cost of such aggressive customer acquisition/retention strategy and the intensively competitive environment, management is making reasonable progress on the AUD 2.5 billion cost-out program. Underlying fixed costs reduced by a further 4.2% in the half (AUD 900 million to-date since fiscal 2016), but without negative impact on customer service (net promoter scores up 2 to 3 points).

It is possible the interim fully franked DPS of AUD 0.08 disappointed the market, given consensus expectation was a half to one cent higher. However, we are comfortable with the board's decision to stay conservative with a payout ratio of 77%. Indeed, the interim dividend was higher than our AUD 0.075 forecast, and it would have been more of a concern if Telstra went back to agonising over this issue, having just taken off the dividend shackles to combat the enormous competitive, structural and company-transformation challenges.

As such, we saw little in the result to warrant a change in our forecasts or the AUD 4.40 fair value estimate. This is particularly as all the fiscal 2019 full-year guidance metrics were reiterated, with projected normalised EBITDA guidance of AUD 8.7 to 9.4 billion in line with our AUD 9.0 billion estimate. Shares in Telstra remain attractive, trading at a 28% discount to our intrinsic assessment, yielding 5% fully franked.

Fiscal 2019 first-half reported net profit after tax, or NPAT, fell 28% year on year to AUD 1,233 million, impacted mainly by AUD 328 million in restructuring charges related to the T22 transformation program. On an underlying basis, NPAT declined 26% to AUD 1,553 million. The interim DPS of AUD 0.08 was down from AUD 0.11 a year ago. The composition of this dividend was AUD 0.05 from underlying earnings (payout of 84% versus policy of 70% to 90%) and AUD 0.03 from net one-off receipts from the National Broadband Network, or NBN (payout of 68% versus policy of 75%).

First-half underlying EBITDA (inclusive of net one-off receipts from the National Broadband Network, or NBN) was down 15% to AUD 4,676 million. As highlighted above, the mobile division was the standout performer. While first-half EBITDA was down 6% to AUD 1,905 million, it is tracking above our full-year expectation of an 8% fall, with Telstra competing aggressively (and successfully) for customers in the important post-paid segment. Recurring NBN receipts also increased 28% to AUD 345 million, while global connectivity lifted EBITDA by 15% to AUD 155 million. The data and IP division also fared better than expected, with EBITDA down just 6% to AUD 782 million, tracking better than our full-year forecast of an also 8% fall.

On the negative side, the fixed-line businesses continued their slide, with first-half EBITDA down another 29% to AUD 866 million. This was compounded by a 66% slump in network application services, or NAS, EBITDA to AUD 39 million, hit by a reduction in NBN commercial works (which can be lumpy) and a fall in other one-off revenue in the managed data networks space.

The group ended December 2018 with net debt/EBITDA of 1.7, still within the board's comfort zone of 1.3 to 1.8. This was despite free cash flow coming in at AUD 627 million, down from AUD 1,716 million a year ago—a well-telegraphed fall owing to lower earnings, bringing forward of capital expenditures, working capital movements, and restructuring cash costs. However, management reiterated full-year free cash flow guidance range of AUD 3.1 to 3.6 billion, albeit likely towards the lower end given the relatively weak first-half outcome.