Telia: behåller 40 kr fair value trots coronakrisen

AKTIE: Kostnadsbesparingar, fokus på Norden och köpet av TV4 kommer framöver att höja Telias lönsamhet. 5G kräver ökade investeringar, men Morningstars analys ger 40 kronor som en fundamentalt motiverad aktiekurs (22 april 2020).

Morningstar Equity Analysts 2020-04-22 | 14:06
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Analyst Note |   Apr 22 2020

Narrow-moat Telia reported first-quarter revenues of SEK 22.4 million, a 2% organic decline over the first quarter of last year. In the quarter, adjusted EBITDA declined by 5% over last year, like for like, as the newly established TV and media unit suffered from coronavirus headwinds. We update our full-year 2020 forecast mainly to account for EBITDA contraction in TV and media. The EBITDA impact on the unit is quite significant, but we estimate the unit contributed only 5% to group EBITDA. We now expect the unit’s EBITDA to be in the range of SEK 0-0.5 billion this year, versus SEK 1.5 billion in 2019. Given the limited impact on the other businesses and our assumption of a full recovery in 2021, the overall effect on our fair value estimate isn't significant and thus we maintain our fair value estimate at SEK 40.

Compared with the same period last year, the group's largest markets of Sweden, Finland and Norway reported a total sales decline. However, group mobile revenue growth came in at 1%, with mobile ARPU increasing in all markets, except Denmark. In Sweden, lower equipment sales more than offset the almost flat growth in service revenues. In Finland, total sales were down 1.4% due to lower fixed services and equipment sales. In Norway, mobile service revenue growth, driven by B2B, was more than offset by lower TV revenues. At the group EBITDA level, the traditional telecom business grew adjusted EBITDA by almost 2%, mainly supported by the Baltic markets and Sweden.

Management has suspended its EBITDA guidance and cut the 2019 dividend to SEK 1.80 per share, from previously announced SEK 2.45. Advertising revenues at Bonnier, the TV and media unit, are expected to decline abruptly, with the global cancellations of sport events also having a negative impact. Like its rival Tele2, Telia remains committed to its opex reduction plans. However, if the pandemic continues longer than expected, margin expansion will be affected by bad debt and credit losses.

Business Strategy and Outlook  |  18 Dec 2019

After the divestment of its Eurasia operations, Telia has exclusively become a Nordic and Baltic telecom player. Telia’s endeavors into emerging markets, which were expected to deliver higher growth rates than developed markets, were unsuccessful. As a result, Telia retracted to markets closer to its home where telecom growth is expected to stagnate.

In search of growth drivers, Telia redeployed its resources into both traditional and less traditional telecom areas. On the traditional front, Telia complemented its core businesses by acquiring fixed-line assets (TDC) in Norway last year to drive fixed-mobile convergence. As with most of its European peers, Telia’s strategy has been to bundle mobile and fixed-line offerings, and it has this capability in most of its markets. In Europe, telecom operators perceive the fixed-mobile convergence as a key strategy to retain customers by offering an integrated solution and cross-selling additional services. The firm is also looking to capitalize on 5G and position itself as a main technology solution provider (cloud, Internet of Things, and security). However, these offerings are still emerging.

On the less traditional front, the firm entered the content space (Bonnier Broadcasting acquisition in Sweden), a less proven strategy that comes with significant cost burden. In our view, telecom firms should follow the aggregator model by partnering with media players rather than acquiring them. We expect Telia to generate solid cash flow from its core operations, but it is grasping at areas in search of growth that could be value destructive.

During its 2019 capital market day presentation, Telia announced its ambitions to reorganize operations into a new operating model and achieve cost efficiencies at the country and group levels. The new operating model, which aims to centralize product development activities and IT services, coupled with cost programs at the country level to reduce administrative, commercial, and sourcing costs, should help the firm achieve margin expansion.

Fair Value & Profit Drivers  |  22 Apr 2020

We are maintaining our fair value estimate at SEK 40 per share. We updated our valuation for 2019 results and accounted for the coronavirus' impact on Telia's businesses. We expect telecom services to experience a limited decline, however the newly established TV and media unit's revenues and earnings for this year will decline abruptly due to lower advertising revenues. Next year, we expect the unit to recover.

With most of Telia’s operations concentrated in mature markets, we expect sales growth to stagnate or to grow at very low rates. We assume organic revenue growth to be primarily driven by wireless, as fixed-line revenue continues to decline. The wireless segment should grow due to increasing average revenue per customer, with more users upgrading to higher-end data plans. The latest acquisition, Bonnier Broadcasting in Sweden, will boost top-line growth next year since we account for a severe decline in advertising revenue in 2020. We project the firm to achieve low-single-digit growth in 2020 and high-single-digit growth in 2021, followed by growth at very low rates. With the successful divestitures of most of its Eurasian assets, we expect management to focus more on cost efficiencies. Despite the COVID-19 unfavorable context, management is committed to reduce operating expenses and to implement a new, more efficient operating model. We expect the firm to achieve cost efficiencies due to process optimization, digitalization and cost reductions programs at the country level (for example reduction in administrative and commercial costs). We expect EBITDA margin to reach 35% at the end of our five-year explicit forecast period from 33%, currently.

We estimate 2020 capital spending of SEK 14 billion. In future, we expect capital spending to increase because of the 5G roll-out, which should be only partially offset by capital spending efficiencies brought on by the new operating model that aims to improve the firm’s sourcing capabilities.

Scenario Analysis  |  22 Apr 2020

In our bull-case scenario, our fair value estimate is SEK 53 per share. In this scenario, we assume the firm's wireless and broadband operations in Western Europe to continue to grow, driven by high data usage and stronger ARPU growth. In the fixed-line business, we forecast legacy decline to finally stagnate. Additionally, we project heavy adoption of extra data services and IoT offerings. This results in the group’s total organic growth to reach 2% in the next five years, versus below 1% growth in our base case. At the operating income level, we expect the firm to achieve higher efficiencies due to its operating model transformation. As a result, Telia’s EBITDA margin reaches 39% at the end of our explicit forecast period versus 35% in our base case.

In our bear-case scenario, our fair value estimate is SEK 28 per share. In this case, we expect wireless services to stagnate or to even slowly decline in some markets, due to the firm’s inability to drive ARPU growth. Telecom players will irrationally compete to introduce bundled services through price to increase their customer bases. Additionally, we account for declining fixed services and advertising revenues. In this worse-case scenario, we also assume management fails to achieve cost efficiencies and the EBITDA margin stagnates at a low 32%.

Economic Moat™

We believe Telia has a narrow economic moat as a result of cost advantages and efficient scale.

Telia's efficient scale advantage stems from the very high capital costs required to build and maintain a network. In the wireless space (wireless dominates Telia's portfolio), we identify four primary costs of entry: spectrum, network equipment and construction, customer acquisition (for example advertising, commissions, subsidies on phones), and startup losses (revenue over the first couple years, at least, will likely fall short of fixed operating costs). By country, we mainly judge Telia’s competitive position according to its ability to generate profits out of its network assets and its market position. All of Telia’s markets are highly concentrated, with three established dominant players holding 80% or more market share. In concentrated markets, margins are usually stable and solid, and the established firms are generally rational. Price wars tend to be to their detriment thanks to similar network quality, and market share gains are difficult to achieve. Telia’s markets match these characteristics, so we believe the firm enjoys the efficient scale advantage in all its markets and a change in the competitive environment is unlikely.

Telia’s scale in each of its geographical markets is vital for firm’s ability to achieve economies of scale. Each country has its own network with its own fixed costs. The more subscribers on a network, the more fixed costs can be spread out, reducing the cost per subscriber. As the largest operator in Sweden and judging by its EBITDA margins relative to peers, we believe the firm has a cost advantage over its competitors. In Sweden it holds 54% of the fixed-line market, 33% of the broadband market, and 35% of the wireless market. Those figures are 17%, 26%, and 32%, respectively, in Finland. Telia is the largest wireless and fixed-line carrier in Lithuania and Estonia as well as the largest wireless operator in Latvia.

Thanks to the efficient scale advantage in each of these countries and its cost advantages over rivals in Sweden, we expect Telia to continue generating strong free cash flow and returns on invested capital.

Moat Trend

We rate Telia's moat trend as stable. Many of the countries in which Telia operates have only three main operators--a structure prone to rational pricing and solid results for all. While in some markets a challenger is present, we do not foresee such firms as real rivals for Telia given the firm’s scale and network size and quality. Thus, we expect the firm to remain the dominant telecom firm in Sweden and to maintain its number-one or -two position in the wireless segments in most of the countries in which it operates. Any change to the market would likely require government or regulatory action, which we don’t believe is likely over the next several years. Holding scale is necessary for Telia to maintain its moat. In most countries Telia has successfully maintained its wireless subscriber base while increasing its average revenue per user.

Risk & Uncertainty

With the firm exiting emerging markets and settling the charges against it in Uzbekistan for $965 million in 2017, we give Telia a medium uncertainty rating. The firm’s only remaining emerging market risk exposure is through its 24% stake in Turkcell, which operates in Turkey, Ukraine, and Belarus.

Regulatory risk is also a common treat for telecom firms since regulators’ objective often is to increase competition. Consequently, established players are scrutinized for both past and current anticompetitive practices. In a market like Norway, which is almost a duopoly between Telenor and Telia, the government might favor smaller players. Thus, the challenger Ice Norge in Norway is a potential competitive threat. The Norwegian market dynamics could change if ICE succeeds in strengthening its network and increasing its customer base. An aggressive price strategy might cause Telia’s market share to decline. Nevertheless, Telia’s position in Norway has strengthened with its fixed-line asset acquisition.

Financial Strength
Telia has a net debt/EBITDA ratio of about 3.2 times in 2019, which is at historically high levels and well above its main competitor, Telenor. The firm had SEK 18 billion of cash and current investments and SEK 119.7 billion of debt as of Dec. 31, 2019. We expect the firm to generate around SEK 55 billion in total free cash flow over the next five years. Additionally, Telia’s current dividend policy is to pay a minimum of 80% of free cash flow from continuing operations, excluding spectrum license payments, as dividends. Given current cash levels and our free cash flow projections, the firm might struggle to significantly reduce its debt while maintaining its dividend. Thus, Telia may have to cut its dividend if it wishes to reduce its leverage. At the current leverage ratio, we believe firm’s strategic flexibility is decreased (for example potential acquisitions, additional business investments, increase dividend payments to shareholder).

Stewardship  |  18 Dec 2019

We are upgrading Telia Company’s stewardship rating to Standard from Poor after a series of moves that we see as wise. Our former Poor stewardship rating was attributed to Eurasia, which represented a significant portion of Group’s revenue and operating income. The firm has exited Eurasia entirely, a region that struggled with corruption allegations that led to management and boardroom changes. The firm’s operations are now concentrated in Europe. The most recent acquisition, TDC in Norway, while completed at a rather expensive EBITDA multiple of 12 times, strengthens Telia’s position in the country as a fully converged player. At the current leverage levels, we believe management is now much more focused on paying down debt and returning cash to shareholders--through dividends and stock buybacks--than making additional acquisitions.

Current CEO Johan Dennelind was appointed in September 2013 and recently announced his plans to leave Telia by 2020. We believe Mr. Dennelind successfully led Telia during turbulent times by refocusing the firm’s operations closer to its local market and strengthening its culture.

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