Telstra held its much-anticipated strategy day this week and management addressed a number of key issues that have been raised by investors over the past few months, including the following:
Aggressive headcount and cost reductions;
A rebase of the mobile business to compete more aggressively for market share; and
A structural separation to extract value from the prized infrastructure assets.
In light of the negative share price reaction following these announcements and the much weaker FY19 guidance, we estimate the shares are now trading at fair value – excluding the separation of the infrastructure arm – based on the expected dividend yield.
In our view, however, a structural separation is still in the company’s best interests, and we expect it will occur eventually. We estimate a spin-off, in its current proposed form, could yield more than 20% potential upside from current share price levels, leading us to maintain our Accumulate recommendation with a $3.30 target price.
We make the following observations:
Management’s FY19 revenue guidance of $26.6–28.5bn and operating earnings (EBITDA) guidance of $8.7–9.4bn were much lower than our previous estimates of $29.5bn and $11.4bn, respectively. $1.3bn of the $2.4bn EBITDA difference at the midpoint could be attributed to the timing of NBN one-off receipts, while management attributed the rest of the difference to increased competitive pressure in all segments of its business. Accordingly, we have lowered our FY19 revenue and EBITDA estimates to $27.7bn and $9.1bn, respectively.
Management announced the creation of an ‘InfraCo’ business unit, although it pushed out the timing of a potential spin-off to follow completion of the NBN rollout in 2022. A lot could change between now and then, however, that could spur the separation to happen sooner rather than later. We estimate this could yield more than 20% potential upside based on the proposed structure.
With the material rebasing of FY19 earnings, we now expect the FY19 dividend to be cut again to 18c per share in FY19 and FY20, under the current capital management framework, and 15c per share from FY21, representing a 6.5% and 5.5% yield, respectively.