Telstra won't be blown away by headwinds

Glenn Freeman | 17/07/2017

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Glenn Freeman: I'm Glenn Freeman for Morningstar. I'm joined today by our senior equity analyst, Brian Han.

Brian, thanks for joining us today.

Brian Han: Thank you, Glenn.

Freeman: Now, Brian, just firstly, what can shareholders expect to hear from Telstra in its upcoming fiscal 2017 earnings result?

Han: Yes. First of all, operationally, I think Telstra will reiterate that the competitive intensity in the telco market is intensifying, especially in mobile and fixed-line broadband. But secondly, and perhaps more critically, we expect Telstra to shed some more light on its capital management review and actually say a few more words on what it intends to do with the dividend payout ratio and whether ahead of the NBN challenges whether it can still pay out more than 90 per cent of its earnings in dividends going forward. So, those will be the two areas that will be particularly focused on.

Freeman: And Brian, in your recent report on Telstra you talk about a whirlwind of recent negatives for the company. Can you just recap some of those for us?

Han: Sure, Glenn. Firstly, it's their competitive intensity, rising competitive intensity, that I just spoke about. The second thing is this NBN. So, we are gradually seeing the impact of the NBN increasing on Telstra. And when NBN is fully rolled out in about four or five years' time, it will punch a $2 billion to $3 billion earnings hole in Telstra and that is quite significant considering that Telstra has about $10 billion-$10.5 billion of EBITDA earnings per year. So, that's the second headwind.

And the third headwind is, back in April we found out that TPG will enter the Australian mobile telephony market because they laid out $1.3 billion to buy the spectrum. Now, that obviously will have an impact on Telstra's own mobile business and that Telstra's own mobile business accounts for about 40 per cent of Telstra's earnings. So, those are the three negative headwinds that I'm referring to.

Freeman: And this NBN earnings hole that you speak about, are you still confident that Telstra is able to plug this shortfall?

Han: Yes, we are, in due course. We are confident because, number one, we do believe that there are a lot more productivity benefits and cost savings to come at Telstra. Secondly, we do believe that they will get extra returns from the incremental $3 billion of capital expenditures that they are going to spend on the infrastructure over the next couple of years. And then thirdly, we do expect earnings growth from businesses such as network application services and global connectivity and also, earnings growth from a myriad of businesses that they have interest in, in areas such as e-heath and cybersecurity. So, when you consider all of that, we do believe that in due course they can mostly plug that $2 billion to $3 billion earnings hole caused by the NBN.

Freeman: And Brian, just lastly, you also speak about TPG's entry as a fourth major mobile network player. How confident are you that Telstra can maintain its position in the face of the additional competition?

Han: Glenn, there is no hiding the fact that TPG's entry will be negative for Telstra. But I do believe that the impact on Telstra won't be as severe as most people think. And I say that because I think the relative impact will be greater on the likes of Vodafone and Optus. The reason why I say the impact will be relatively limited on Telstra is because, number one, I think the number of years it's going to take TPG to roll out their mobile network and to fully ramp up to full operation will be many, many years and probably not until fiscal 2026 that we are going to see a fully ramped-up TPG mobile network.

The second reason is, I think TPG's mobile network will be inferior to the likes of Telstra and Optus simply because they have already said their target coverage is 80% and as you know, Optus and Telstra, they are almost 100%. So, network inferiority is another reason why we think impact will be limited.

And the third reason is, TPG doesn't have the infrastructure or the amount of cell towers and cell sites, nor the amount of capital expenditure behind them to maintain these networks. So, because of that inferiority in terms of the infrastructure breadth it means that network inferiority will be a limiting factor in TPG getting a reasonable penetration into the business and corporate mobile market because as you can appreciate, business and corporate customers network superiority and network coverage are very important considerations. So, those are the reasons why we believe that TPG will have an impact but the impact won't be as severe as most people think.

Freeman: Thanks very much for your time today, Brian.

Han: Thanks, Glenn.

Freeman: I'm Glenn Freeman for Morningstar. Thanks for watching.

This report appeared on 2017 Morningstar Australasia Pty Limited

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