Chorus says fatter dividends on the way, unless regulator has other ideas

New Chorus boss JB Rousselot. Photo / Supplied

Analysts are sharpening their pencils after Chorus confirmed once it puts the capital-intensive UFB rollout behind it in a couple of years, free cash flow will increase - and the majority of it paid out in dividends.

Wealth manager Jarden sees the increase in free cash flow underpinning a steady stream of dividend increases over the next decade. Research analysts Arie Dekker and Grant Lowe sees the 24 cents per share confirmed for financial year 2020 doubling by 2025.

There is an "if" however - and it's if the Commerce Commission's final thinking on the new regulatory regime lands close to where Chorus wants.

An update to the Telecommunications Act comes into effect between January next year and mid-2022 and will see Chorus regulated like a utility. On July 12 the commission - which is refereeing how the new legislation is imposed - mooted a change to the way Chorus would be valued, which will in turn feed into the revenue cap that the regulator will impose, and other operating parameters.

Chorus shares swooned, if briefly, as chief executive JB Rousselot said he didn't like the ComCom possibly changing direction from the so-called "building blocks" model at what he saw as the last minute. And today, the newish chief executive underlined that the regulator could be leaning in the wrong direction - from Chorus' point of view - and underplays factors that determine criteria such as the weighted average cost of capital.

On a conference call with analysts, Rousselot said that, currently, there appeared to be "a significant gap between [the Commission's] retrospective economic assumptions and commercial reality."

Investors would not get a return reflecting the risk they took early in the UFB project under the settings in the Commission's latest draft, he said.

"The dynamics that influence [dividends] are complex and the ComCom is looking to balance outcomes for both investors and end-users,' Jarden research analyst Arie Dekker says. Photo / File

"If this occurs investors, will not consider UFB a model for the successful transformation of additional New Zealand infrastructure," Rousselot said - closely echoing the "don't scare off foreign investors" line Chorus used, with a degree of success, during its negotiations with the previous government over copper line regulation half a decade ago.

Jarden's Dekker told the Herald, "There are important principles at stake in Chorus's concern regarding ComCom's approach to risk and return on the investment Chorus has made. The dynamics that influence [dividends] are complex and the ComCom is looking to balance outcomes for both investors and end-users."

Dekker has a neutral rating on Chorus, in part because of the regulatory uncertainty (although the 5G fixed-wireless threat also lurks; more on that soon).

Rousselot - who is French but has spent most of his career in Australia with Telstra and the NBN - is already getting a taste of Kiwi politics just months into his new role, with retail ISPs lobby against his company on several fronts, and are in the ComCom's ear as it weighs how to set the final rules for the UFB era.

Vocus (owner of Orcon and Slingshot) was on the front-foot soon after Rousselot announced this morning's results, using its relatively robust financial result, and positive outlook amid the pandemic, as another argument against Chorus's wholesale broadband price rises on the way from October 1.

"It's a cynical profit grab – straight from middle New Zealand's wallets," Vocus consumer GM Taryn Hamilton said. (More on the price-rise barney below).

Inline profit

Earlier, Chorus delivered a full-year result broadly line with analyst expectations and guidance as it braces for new regulatory and technology challenges.

The network operator reported net profit for the year June 30 of $52 million against the previous year's $53m, a nose behind Jarden's expectation of $54.4m.

Ebitda rose to $648m from last year's $636m. Jarden had been expecting $651m.

Revenue - hit by Covid as new connections paused during the first lockdown - was $959m vs the year-ago $970m, but it was balanced by a fall in expenses during the same period. On a conference call, CFO David Collins put the cost of the pandemic at $12m.

The final dividend was 14c per share for a full-year payout of 24cps, again in line expectations.

Full-time equivalent staff was down 5 per cent, Collins said, following a restructure late last year. And Chorus paid $8m less to the annual $50m Telecommunicals Development Levy as its total number of lines fell.

"It's a cynical profit grab - straight from middle New Zealand's wallet," says Vocus GM Taryn Hamilton on Chorus' pending price increase on the most popular type of UFB plan. Photo / Leon Menzies

Chorus shares have been on a bull-run over the past 12-months as the UFB rollout enters its final stages, and investors start to look ahead to years of lower-capex and higher dividends.

That run continued today; shares rose 2.4 per cent to $8.20 in early trading. The stock is up 59.6 per cent for the year.

Butn a note last week, wealth manager Jarden raised its 12-month target price from $6.40 to $7.18 but kept its rating at neutral.

Research analysts Arie Dekker and Grant Lowe highlighted two negatives: "opaque investment settings" or uncertainty around where the Commerce Commission will land with a series of decisions that will cap Chorus' revenue once a new regulatory regime kicks in, and the rise of fixed wireless broadband alternatives from Spark, Vodafone and 2degrees (using their mobile networks to deliver broadband into a home or business, cutting Chorus out of the loop).

The retailers already have close to 200,000 on fixed-wireless access (or FWA). Jarden says it will be watching Spark (which reports tomorrow) closely for any update on its plans for 5G-enabled fixed-wireless. Chorus might have to cut the price of its lower-end UFB product to compete, Jarden says - potentially crimping its short-term free cash-flow.

In the meantime, Jarden notes that by cutting prices on its top plans and raising them on its cheapest, Chorus has been "taking the alternative and logical approach of incentivising
RSPs to push end users towards a 1Gbp product that is raising ARPU" [average revenue per user per month".

Fatter dividends ahead

Even with its caution about regulatory uncertainty and the fixed-wireless threat, Jarden sees Chorus' full-year dividend rising from 24cps in 2020 to 25cps next year, then 33cps the year after.

Dekker and Lowe see the really fat payouts from FY2023, when they're picking 40cps, then 45cps then 50cps over the following two years - rising to 54cps by 2029 as Chorus sits back and enjoys the big boost in free cash flow after the heavy-spending UFB rollout years.

At Chorus' interim result in February, CFO Collins said the company was aiming to payout the "majority of free cash flow" as dividends after 2024, with an increase during a 2022-24 transition period.

But the company's largest shareholder - Crown Infrastructure Partners, with its 58 per cent stake (albeit in non-voting shares) - will have to wait four years for is dividends, however. Collins said the delay was a nod to Chorus' funding non-standard UFB installations (originally, people with the likes of long driveways were going to pay toward their fibre install) and the two-year delay finalising the new regulatory regime.

And CEO JB Rousselot said the Commerce Commission's current stance potentially threatened the future payouts - which he said, in turn, would push investors away from future public-private infrastructure upgrades (a similar line to what Chorus used - with a degree of success - in the "copper tax" war of the mid-twenty teens.

UFB growth, fall in lines overall

Chorus - which earlier disclosed 15,000 fewer installs than originally forecast during the March and April lockdowns - said its total number of active UFB connections increased from 610,000 to 751,000 of FY2020.

As expected, its total number of lines dipped from 1,450,000 to 415,000 as some copper customers upgraded to fiber outside Chorus areas, and some plumped for fixed wireless.

In terms of traffic, Chorus reported all time-highs during the March and April lockdowns, as the volume of data surpassed the 2019 Rugby World Cup spike, but there has been a more modest series of "mini surges" during the latest round of lockdowns.

Collins said there had been a "V-shaped' or faster-than-expected recovery in UFB installation business after the first round of lockdowns. Cost-per-premise was $1558, at the mid-point of expectations.

Traffic surged about 67 per cent during the first round of lockdowns, but there was also around a 10 per cent lift that persisted as the nation returned to level 1 as more people remote worked.

Rousselot said the overall UFB rollout was now 88 per cent complete, with 150,000 still to pass - with its second and final phase due to be complete by the end of 2022 (see the government's latest rollout tracker here).

FY 2021 guidance

Collins issued guidance for the current financial year on a conference call with analysts - making Chorus one of the few ICT companies, or companies full-stop to do so.

Chorus is guiding to $640m - $660m ebitda for FY2021.

Capital expenditure will be $630m - $670 million.

And it is picking a full-year dividend: 25 cents per share, "subject to no material adverse changes in circumstances or outlook."

The CFO stressed there was a degree of uncertainty, saying "No one knows how many more lockdowns will they be and how long will they last."

But he also said Chorus was on track to transition to its new dividend policy - that is, paying out a majority of free cash flow - after 2022.

Following the end of the UFB, there would be "sustaining capex" of around $200m per year, Collins said.

Retailer grumbles

The pandemic has barely broke Chorus's stride, bar UFB installations briefly being put on hold during the first lockdown.

Retailers like Spark, Vodafone, 2degrees and Vocus have complained they have had to bare the cost of measures such as suspending disconnections for late fees, and waiving fees for excess data.

Chorus has proposed a $2m assistance package for retail ISPs; they want a lot more.

Retailers have also banded together to call on Chorus to delay a $1/month wholesale price increase on the most popular type of UFB fibre plan )100 megabits per second) from October 1, so far with no success.

Chorus says it needs to raise the cost to continue investing. The company points out it did trim the cost of its small business plan and power-user 1 Gbit/s (1000Mbit/s) plans in July.

The network companies bull-run on the stock exchange has had two blips this year. The first came when it was caught up in the general pandemic panic in March.

The second was on July 12, when it made two announcements. The first announcement was expected. Chorus had already warned that level 4 lockdowns would hit UFB installations, which it today said fell by around 15,000 during its financial year fourth quarter because of restrictions on non-essential activity.

The second was a surprise. Chorus said the Commerce Commission had told it there would be a discussion paper coming out in August, which will moot a change to the way Chorus is valued - which will in turn feed into the revenue cap that the regulator will impose, and other operating parameters when an update to the Telecommunications Act comes into effect between January next year and mid-2022.

"The Commission says the changes they are considering in relation to the financial loss asset involve adopting a discounted cash flow approach to valuation, rather than the building blocks approach proposed in its November 2019 draft decisions, and a different treatment of investments that pre-date the UFB Initiative," Chorus said in a statement.

Rousselot said it is disappointing that a potentially significant change of this nature is being considered this late in the commission's process.

Dekker and Lowe say until the Commerce Commission finalises the parameters it will use to calculate Regulated Asset Base and Maximum Allowable Revenue, any punts about the network company's future value will be subject to a "high margin of error."

Collins said this morning that it could be mid-2021 before the new regulatory regime was finalised.