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Morningstar | Telefonica Brasil Reported Light 1Q Results; Shares Fairly Valued

Telefonica Brasil reported first-quarter results that were a bit weak, but we don’t expect to make any significant changes to our $12 per ADR fair value estimate beyond updating our exchange rate to account for the weakening of the Brazilian real versus the U.S. dollar. We continue to believe the company has no moat and the shares are fairly valued.

Reported revenue grew 1.7% year over year versus our full-year projection of 2.4%. While this is a smaller miss than from TIM Brasil, the weak economy and increased competition are hurting the sector. However, we are pleased with Telefonica’s strategy and continue to believe it will lead to faster growth over time. The firm increased its postpaid subscriber base by 9.4% from the year ago period to 41 million, which now accounts for 55.8% of its wireless subscribers as its prepaid base shrank by 13.5% to 32.5 million. Telefonica’s smaller prepaid base relative to TIM Brasil helped the firm’s wireless business to outperform its rival with revenue growth of 4.7% in the quarter. The company generated 1.6% higher average revenue per user on its postpaid base and saw its handset revenue jump by 55.1%. While margins are lower on handset sales, Telefonica does generate some profit from handset sales, unlike some European operators.

However, the better wireless revenue was partially offset by a 3.2% decline from its fixed-line business. While the firm generated strong broadband subscriber growth from fiber-to-the-home of 44.1% to 2 million customers, this was more than offset by an 11.3% decline from other technologies to 5.4 million subscribers. That said, we are pleased with the firm’s push into fiber, which led to a 12.7% ARPU increase to BRL 62.20 and will enable Telefonica to distinguish its broadband product from its competitors.

The firm’s EBITDA margin before leases was also light at 35.6% versus our full-year projection of 37.2%. However, since its EBITDA margin has historically been lumpier than many phone companies from one quarter to another, we aren’t ready to change our position due to just one quarter of underperformance.