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Morningstar | Telefonica Brasil Reports Generally In-Line 2018 Results; Shares Fairly Valued

Telefonica Brasil reported 2018 results that were generally in line with our projections, and we don’t expect any significant changes to our $12.50 per ADR fair value estimate. Our no-moat rating is unchanged, and we believe the shares are fairly valued. The firm reported revenue grew 0.6% year over year versus our expectation of a 0.2% gain.

The wireless business continued to improve with revenue growth of 3.4%. While the firm's overall wireless customer base declined 2.4% to 73.2 million, the more valuable postpaid base grew 9.9% to 40.4 million and now accounts for 55.2% of the wireless base. This is a very impressive level for an emerging-market country. The change in mix led to a 0.5% increase in average revenue per user for the year and 1.2% for the quarter, which bodes well for 2019. However, competition is increasing, as reflected in Telefonica Brasil capturing only a 26.1% share of postpaid net additions, although part of this is due to having already converted a larger percentage of its existing customers to postpaid.  Prepaid churn also increased to 6.8% in the quarter versus 4.8% in the year-ago period. This is an area we will continue to monitor. The biggest gain in wireless revenue was from handset sales, which jumped 70% in the quarter and 56.5% for the year, which we don’t believe is sustainable.

The revenue growth on the wireless side continues to be mostly offset by declines on the fixed-line side, which fell 3.5% for the quarter and 3.8% for the year. That said, the firm is progressing in moving broadband customers to higher speeds, particularly fibre to the home, which jumped 46.8% to 1.9 million subscribers, and pay-TV customers to IPTV, up 52.1% to 579,000, from satellite delivery. We expect this transition to continue, which is helping ARPU. In the quarter, broadband ARPU increased 11.8% to BRL 62.8 ($16.91) per month, and pay-TV ARPU improved 6% to BRL 104.3.

We anticipate the continued transition to higher-value customers and ARPU will allow the fixed-line business to significantly reduce its revenue decline in 2019 and generate some small revenue growth in 2020.

Telefonica Brasil is also making progress on cost-cutting. Together with higher other net operating revenue, its EBITDA margin rose to 41% versus our projection of 41.1%. However, we expect gains from other operating revenue to be much smaller going forward, which is likely to push the EBITDA margin below 38% in 2019.