Telstra Corp Ltd (TLS)

Stock: Telstra Corp Ltd
Exchange: ASX Symbol: TLS
Date: September 12, 2019 Latest price: $3.59 AUD
Market Cap: $42.9 bn Fair Value Estimate: $3.83
Forward P/E: 16.6 Fair Value Payback: 13 Years
Financial Y/E: 30 June Rating: Hold
Sector: Communications Services Industry: Telecom Services
Investment Theme: Dividends & Growth Forward Dividend Yield 2.81% (fully franked)

Summary

Telstra is a defensive stock with dominant market share in mobile, broadband and the rapidly shrinking fixed line market.

We assign a fair value of $3.83 based on an EBITDA of $7.7 billion (net of $3 billion hole from NBN roll-out less $1.3 billion in expected cost savings), 4% long-term growth, $10.7 billion compensation from the NBN rollout (net of expected future redundancy costs), a 10% margin of safety and a 13 year payback period.

Telstra would not be suitable for international investors who cannot take advantage of franking credits on dividends.

Our current rating is HOLD because of the correction on the chart below. We plan to upgrade this to BUY if Trend Index (13-week) forms a trough above zero.

Recommended portfolio weighting is 5% of portfolio value.

Technical Analysis

Telstra is currently undergoing a correction after an impressive rally since the start of 2019. We expect the correction to find support at $3.20. A Trend Index trough above zero would indicate buying pressure.

Twiggs Momentum and Trend Index (13-Week)

Company Profile

Telstra is the largest player in the Australian telecommunications industry and owns and operates an extensive telecommunications network. Telstra markets voice, mobile, broadband and pay television (35% of Foxtel) and enjoys strong brand recognition. They boast the widest mobile coverage and jealously guard competitor access to their network.

Competitors & Markets

Optus (a subsidiary of SingTel) competes mainly in mobile, broadband and voice. It owns and operates its own network but also uses the wholesale services of the NBN and Telstra. Optus was making inroads in the broadband and mobile markets, bundling services with free sports coverage of the 2018 Soccer World Cup, but this led to an embarrassing failure when their network proved incapable of handling the traffic volume.

TPG Telecom Ltd (TPM) is an Australian telecommunications company and one of the fastest growing domestic Internet service providers in Australia.  Under the TPG, AAPT and iiNet brands, the group enjoys a 26% share of the Australian broadband subscriber market (or 1.9 million subscribers). Margins have suffered as migration to the NBN grows.

TPG proposed a merger with third mobile network provider Vodafone but this has so far been blocked by the Australian Competition and Consumer Commission (ACCC) on the grounds that the merger would lessen competition between mobile players. Vodafone has appealed the decision.

The ACCC found that TPG would have the capacity to roll out a new 4G mobile network in the coming years and therefore allowing the two parties to merge would remove this additional competitor from the market. TPG’s counsel Ruth Higgins told the court that TPG's ability to build a 4G network was already outdated with new 5G technology. "5G isn't just a possibility. It's a product." (The Age)

TPG is the second biggest player in fixed broadband and Vodafone ranks third in mobile. A deal would leverage Vodafone's existing underutilized mobile network and save TPG on infrastructure spending. A combined entity would still rank third in mobile but would be more able to compete with Telstra and Optus in the 5G market, spreading the large capital costs over a broader subscriber base.

5G Wireless Network

Extensive capital outlays required to implement 5G are only within the means of the largest players. Telstra's choice of Ericsson as its major 5G supplier has given them an advantage over Optus who had tied up with Huawei before the Australian government banned them from supplying 5G equipment:

Australia's secretary for foreign affairs and trade said her government's guidance to keep equipment from Chinese makers Huawei Technologies and ZTE out of 5G wireless networks was made after national security risks were assessed from "all possible angles." (Nikkei Asian Review)

Why Invest in Telecommunications?

The Australian telecommunications industry has gone through a torrid time in the past two years, with disruption from the National Broadband Network (NBN) eroding the competitive advantage of larger players and consequently margins. The ASX 300 Telecommunications Index fell more than 56% between 2015 and 2018.

ASX 300 Telecommunications Index

The Australian telecom industry occupies a unique defensive position. The industry is dominated by a few players, with low threat of competition from offshore because of the massive infrastructure investment required and high existing levels of penetration in a mature market.

Total number of broadband subscribers increased to 14.21 million in December 2017 from 13.64 m a year earlier (ABS), a growth rate of 4.2%. But data usage is growing exponentially, with downloads up by 38.6% to 3.6 million Terabytes (TB).

Australian Broadband Usage

Source: ABS

Mobile usage shows a similar pattern with subscribers up by 4.9% to 26.7 million by December 2017, while data downloads increased by 39.1%.

Structural trends show promise, with online services and the Internet of things — rising connectivity across devices from motor vehicles to television sets and refrigerators — expected to grow exponentially.

Wireless and mobile data usage are small (9%) compared to fixed line broadband but that is expected to change. Telstra has commenced roll-out of the 5G network which offers data rates of several tens of Mb/s and supports hundreds of thousands of simultaneous connections required for massive sensor deployments under the Internet of things.

Disclosure

Staff of The Patient Investor may directly or indirectly own shares in the above company.