This article was originally published at MF & Co. Asset Management
Telstra (ASX TLS) is one of the largest companies in Australia and is a leader in telecommunication, media and technology.
In Australia, Telstra provides 17.4 million mobile services, 6.8 million fixed voice services and 3.5 million retail fixed broadband services.
Even though Telstra has been affected negatively by the NBN (like most Telcos), Telstra has a lot of upside potential with its new first-to-market 5G network rollout.
NBN Still Posing Challenges For Telstra
Since the rollout of the NBN, Telstra’s bottom line has been under pressure with the obsoletion of their copper network.
There are two ways the NBN is impacting on Telstra, the impact on revenue from customer contracts and on the fixed asset base.
Transfer of Assets To NBN Co.
NBN Co makes decisions as to how its customers access its network, either through FTTP (fibre to the premises), FTTB (fibre to the basement), FTTN (fibre to the node), FTTC (fibre to the curb) or HFC (hybrid fibre coaxial).
During this rollout, NBN Co will then make an acquisition of the relevant Telstra assets. The terms of the transfer of these assets are set out in the Infrastructure Services Agreement (ISA).
In addition, Telstra also gives NBN Co long-term access to other components of their infrastructure.
Under the ISA, Telstra receives a number of payments from NBN Co:
- Infrastructure Ownership Payment (IOP) for certain copper and HFC assets and transfer of lead-in conduits (LICs)
- Infrastructure Asset Payment (IAP) for long-term access to pits and ducts
- Additional payments for access to infrastructures such as exchange rack space and dark fibre
Both the IOP and IAP payments are indexed to CPI, so these payments will grow in line with the NBN network rollout.
Both IOP and IAP are classified as other income and sale of services respectively. In the FY19 report, other income in HY19 was $1.2b, down $370m from HY18. Sale of services was down $439m, from $10.805b to $10.366b.
Telstra does not break down IOP and IAP individually in their financial reports, so it is hard to see how much these two revenue streams contribute to Telstra’s revenue.
IOP and IAP Revenue Not Replacing Revenue From Customer Contracts
However, from looking at the sale of services revenue, the revenue streams from IOP and IAP is not replacing the lost revenue from customer contracts.
This is to be expected, as Telstra would be selling their assets at a wholesale rate to the NBN Co. whilst previous customers would be on higher margin retail contracts. These customers may or may not use Telstra as their telco of choice when connecting to the NBN.
Additionally, Telstra would have lost its margin advantage compared to other providers since NBN Co would own the infrastructure rather than Telstra.
Telstra Continues to Focus On New 5G Network
5G stands for “5th generation mobile”. It builds upon today’s 4G mobile network technology, but offer higher speeds and lower time delays. Telstra also decided to bring further standardization, spectrum allocation, and wide-scale trials of 5G globally.
Telstra recently opened a 5G Innovation Center at its Southport Exchange near the Gold Coast. They plan to test the new mobile technologies in Australian in order to support the commercial deployment of 5G services.
Telstra Commits to 5G Rollout
Telstra’s 5G Innovation Centre is designed to enable collaboration among technology vendors, developers, start-ups and our enterprise customers. Telstra will also conduct 5G field trials in the coming months around the Gold Coast. The Gold Coast will be the location for a meeting of 3GPP (3rd Generation Partnership Project between groups of telecommunications associations) in September to consider the global standards for 5G.
However, the full capacity of 5G will only be achieved through large investments in infrastructure. The 5G Innovation Centre has invested $60 million in the upgraded infrastructure on the Gold Coast to support growing demand in the area.
During HY19, Telstra committed $386m to support its national 5G rollout.
Telstra has partnered with a number of 5G smartphone manufacturers, which will allow customers first-to-market access. They started its national 5G rollout in August last year and will have 5G devices ready for the first half of 2019.
Will 5G Make NBN Obsolete?
Only time will tell. 5G is a new technology so it can potentially take a number of years before it becomes stable and all the bugs are ironed out. However, the stats are daunting.
5G is capable of 20Gbp/s, which is 20,000Mbp/s. The NBN has a current theoretical maximum of 100Mbp/s with most customers receiving only half that.
Even at the max theoretical speed of NBN, 5G is 200 times faster than the NBN.
Other factors to consider for 5G would be the stability of connection and cost of data. The cost of data would be the main issue as to whether 5G can obsolete NBN.
However, if 5G is a much more attractive alternative to the NBN, we could see sign up rates to the NBN fall and Telstra revenue rise as users switch to the much more convenient and faster 5G network.
If this is the case, we should see some strong upside for the Telstra share price.
Huawei Ban Positive News For Telstra
Telstra is currently partnered with Swedish technology company Ericsson for the rollout of its 5G network and is not affected by the ban on Chinese communication products.
Since the ban on Huawei and ZTE by the Australian government, Optus has had to delay their 5G rollout giving Telstra a head start.
TPG Telecom (ASX TPM) has even cancelled its 5G rollout in Australia, with the ban on Huawei equipment as the primary factor behind the decision. Additionally, TPG is now at a strong disadvantage to its peers since they invested $130 million into the rollout of the network. They also had 900 out of the 1,500 sites already or partially completed.
At this point, Telstra is well ahead in the race to get 5G rolled out to Australian users.
Poor HY19 Financial Performance
Thanks to the NBN, Telstra, like most telecommunications companies listed on the ASX continue to perform poorly.
For this comparison, we have used the sub-industry Integrated Telecommunication Services. Stocks in this sector include Spark New Zealand (ASX SPK), Telstra Corporation. (ASX TLS), TPG Telecom Limited (ASX TPM) and Vocus Group Ltd (ASX VOC).
For the full breakdown of financial ratios, go to the MF & Co. Telstra Stock Profile page.
- Growth of net sales was worse than the industry, down 1.74%, compared to -0.73%.
- Growth of EBITDA was much worse, at -11.98% compared to -6.48% for the industry.
- Growth of free cash flow was down -6.59%, much worse than the industry which was up 18.82%. However, this can probably be attributed to Telstra’s investment in its 5G rollout.
- EBITDA margin was 29.48%, well above the industry average of 26.45%.
On a P/E basis as at the time of writing, Telstra is heavily discounted compared to its peers.
|Telstra Corporation. (ASX TLS)||12.68|
|Spark New Zealand (ASX SPK)||19.35|
|TPG Telecom Limited (ASX TPM)||26.02|
|Vocus Group Ltd (ASX VOC)||54.95|
Even though Telstra has performed poorly in HY19, it isn’t much worse than its industry peers. Poor performance is sector-wide as NBN Co. continues to disrupt and squeeze margins in this space.
Telstra Shares Cheap with Strong Upside Potential from 5G
With the strength of a wide range of service, strong customer service and dominant market share, Telstra is still leading in Australia’s telecommunication and technology industry.
However, NBN continues to cause headwinds for Telstra and the high capital cost of rolling out 5G adds additional risk to the company.
Although there are a number of issues, it seems most of the negative news is already priced in.
At this point with the rollout of 5G and the discount investors are pricing into the company compared to its peers, we see a lot of upside for Telstra.
Henry Fung is a Partner Managing Director and co-founder of MF & Co. Asset Management. He is a highly experienced equities, derivatives and financial markets professional with over 12 years of experience. Henry specialises in building trading algorithms & systems, quantitative & qualitative analytics across macroeconomic, fundamental and technical disciplines and currently runs the MFAM VPAC AU/US models portfolios. The management Partners and Adviser team have decades of experience between them, with experience from major Investment Banks and Brokers. Their Advisers are highly experienced, having dealt with some of the wealthiest clients in Australia