Needing to get on the front foot
Telstra (ASX:TLS) shares have come under further pressure since our last review a few weeks ago, and following a trading update yesterday. The company has said that earnings would be at the lower end of the 2018 guidance range of $10.1 billion to $10.6 billion. Management noted a highly competitive market was taking its toll on margins in fixed and mobile.
On the plus side, free cash flow is set to come in at the upper end of the range of $4.2 billion to $4.7 billion. Subscriber numbers have also been growing, although average revenue per user (ARPU) has been falling. The company expects challenging conditions to continue into FY19, with ongoing pressure on ‘mobile and fixed ARPUs and the accelerating impact of the NBN.”
Looking at the third quarter, Telstra reported 36,000 fixed data net additions and a NBN market share at the end of March of 50%. Price competition though has seen the bundle minimum monthly commitment fall 2.4% on the same period last year.
In mobiles, a fall in ARPU also has offset a 60,000 increase in subscribers. Earnings here are set to fall, against last year, in FY18 as a result.
Source: Company Presentation
For the full year management expects income to be in the middle of the $27.6 – $29.5 billion range. Net one-off NBN receipts are set to be at the mid to upper end of the range, as are capital expenditures.
Source: Telstra (ASX:TLS)
With pressure on margins, it is no surprise that the company continues to take costs out where it can. FY18 underlying core fixed costs are set to decline by around 7%. Incremental restructuring costs are though at the top end of the range at $300 million.
Also given the consternation over the divided cut, it was encouraging to see that the outlook for the FY18 pay-out has been held at 22 cents per share. At an investor presentation management was though non-committal about what this would look like for FY19. This has probably further exacerbated weak investor sentiment.
The shares dipped 5% on the announcement, and have been weaker again today. The main thing that alarmed the market was, in our view, the lack of decisiveness shown by management in addressing these clear competitive pressures.
The company noted that “Telstra will provide a further update to the market in the second half of June regarding additional strategies it is implementing to address these pressures, leveraging the investments already made as part of its strategic investment plan.”
Telstra (ASX:TLS) is not unaccustomed to competition, and it would have been more positive to see management come out on the front foot. With a strong brand, Telstra remains in as good a position as any to follow through and plug the earnings hole post the NBN. Management has the tools and brand at its disposal and in our view needs to display more outward confidence here.
Confidence can become infectious, but a lack of it can also be unnerving. This is clear from looking at the chart of Telstra, with the shares now having broken a key psychological support level at $3. We are now of the view that a period of consolidation is likely, and presuming management can in the not too distant future provide some assurance that current headwinds can be surmounted (we remain of the view that they can).
We continue to believe that Telstra (ASX:TLS) has the ability to make the most of the market opportunities that exist, and notwithstanding elevated competition. As CEO Andy Penn stated, the demand for high quality telecom services has accelerated – in data volumes are increasing 50% per annum. The company has responded ahead of the curve, and has upgraded core infrastructure to support 5 times the current data volumes by 2020. Customers want to do things faster, and the company’s investment in 5G is one that will pay off in our view.
Turning to the charts, the picture is clearly weak. Dynamic support sighted at the 50-day moving average (red line) of $3.55 has given way, as has that at $3.34. In order for the short-term technical outlook to strengthen, these need to be surmounted, and a decisive break above our aforementioned resistance range between $3.75 and $3.81 is required. Should this occur, then an eventual glide towards the psychological $4.00 level is deemed feasible. This though seems some way off at present.
With reference to Telstra’s monthly chart, support at the 78.6% Fibonacci retracement of $3.45 (blue set of retracements) has not held. The next significant layer of support is at $2.55. The dominant long-term downtrend remains in play, and therefore, the climb north could be slow in coming. A breach of psychological support at $3 should also not to be ignored.
Summary
Telstra (ASX:TLS) shares have come under further pressure since our last review a few weeks ago, and following a trading update yesterday. The company has said that earnings would be at the lower end of the 2018 guidance range of $10.1 billion to $10.6 billion. Management noted a highly competitive market was taking its toll on margins in fixed and mobile. Subscriber numbers though have been growing and cash flows remain strong.
Telstra is not unaccustomed to competition, and it would have been more positive to see management come out on the front foot. With a strong brand Telstra remains in as good a position as any to follow through and plug the earnings hole post the NBN. Management has the tools and brand at its disposal and in our view needs to display more outward confidence here.
Telstra is doing well in mobile, with a strong brand and should be a beneficiary of the upcoming shift to 5G technology. The company is bearing down on costs, and also investing in strategic initiatives to try and plug the looming NBN earnings hole, although we expect a more meaningful impact is some way off.
At the current valuation, the stock is pricing in very low market expectations and, in our view, there is room for upside surprise going forward. The shares are currently trading on an undemanding 13 times forecast FY18 earnings, falling to 10.7 times the following year. Meanwhile, the projected yield is 6.9% for FY19.
Confidence can become infectious, but a lack of it can also be unnerving. This is clear from looking at the chart of Telstra, with the shares now having broken a key psychological support level at $3. We are now of the view that a period of consolidation is likely, and presuming management can in the not too distant future provide some assurance that current headwinds can be surmounted.
In the meantime, we are shifting our recommendation for Telstra (ASX:TLS) back to a HOLD.
Disclosure: Telstra (ASX:TLS) is held within the Fat Prophets Concentrated Australian Share and Australian Share Income Models.
