Greg Smith: Telstra, the former great on the comeback trail

COMMENT:

There has certainly been action aplenty in the telecoms sector so far this year. The prospect of next year's IPO of Vodafone NZ has been dashed by Infratil's takeover bid, while across the ditch, ASX listed Vocus (the owner of Slingshot and Orcon) has received its second takeover offer (the first bidder walked) in the space of a few weeks. Are the buyers onto something?

Spark's foray into sports streaming has gotten off to anything but the smoothest of starts, raising concerns (both from investors and viewers) about the company's to successfully deliver the Rugby World Cup come September. This also offers some credence to the (our) view that CEO Simon Moutter's sudden departure was about him getting out in John-Key esque fashion – on top, and before the downward slope.

Network operator Chorus has also proved that 'boring' is sometimes just as fruitful, with the shares up more than 20 per cent this year, with sentiment for the most part underpinned by a favourable regulatory regime and robust dividend outlook. The company will also be looking to increasingly position the virtues of its network, over Spark's promoted wireless broadband solution given the latter's recent troubles.

Across the Tasman it has been just as busy, with the aforementioned bids for Vocus, and the regulator stepping in to block a tie up between TPG Telecom and Vodafone Hutchison Australia. The ACCC's view was this it would prevent the creation of a fourth network - TPG abandoned it anyway leading up to the decision.

Which brings us around to the subject of Telstra. The former state-owned heavyweight bears some similarities with Spark, in having a dominant market position but has not had to go down the path of a costly rebranding. And just as well, with the Telstra brand (according to Brand Finance) ranked Australia's most value brand for the fourth year running, with a 'valuation' of $14.7 billion.

Telstra was also never divorced from its infrastructure assets. Instead the Australian government(s) came up with the NBN (national broadband network) where Telstra would 'rent' out key infrastructure assets, and receive compensation for having its wholesale business effectively wiped out.

The creation of a $3b earnings hole thanks to the NBN has not sat well with the market, and also with the telco was inevitably forced to trim its dividend (three times). The shares have lost over 40 per cent of their value in the past four years or.

The value destruction was at lot worse at one point, and TLS has actually been one of the better performing blue chips this year, putting on around 30 per cent. This is a reflection of a successful turnaround effort, while the dice has also rolled the right way for the telco on a number of fronts.

When the bottom line is under pressure, the first part of any turnaround strategy is a cost out plan, and this is a central feature of CEO Andy Penn's 'T22 strategy.' This is running ahead of schedule (with $200 million in restructuring costs recently brought forward to FY19), as the company looks to 'digitise', 'simplify', 'automate' and drive productivity improvements.

By 2022, Telstra will have shed close to 20,000 roles, flattened its management structure and cut its product line from 1800 plans to just 20. The job cuts will reduce the company's payroll by well over $1b by 2022, with the total savings from the T22 cost-cutting programs expected to reach $2.5b. Service is also not being compromised, with automated customer service systems for instance seeing annual call centre volumes down significantly.

Telstra (and rival Singtel/Optus) has also received a boost of sorts from the merger of TPG Telecom and Vodafone being blocked. The could potentially be a significant winner in the 5G opportunity (Australian is further down this track than NZ) given its work in the area already, superior scale and now the spectre of less competition (or at the very least a lengthy delay of the entry of a new formidable competitor).

This also has positive implications for margins, and with the company's mobile business now accounting for half of earnings (70 per cent including fixed connections) and around 40 per cent of recurring revenues.

Telstra also has the benefit of not being affected by the Australian government jumping on the 'ban Huawei' bandwagon. In pursuing 5G growth Telstra has key partnerships with the more 'politically friendly' Qualcomm and Ericsson.

Balance sheet optimisation has also not been forgotten, with the company well advanced it seems to execute on around $2b of asset sales. There has reportedly been keen interest in the company's data centres business at $400m+ while the heavy lifting may also come from selling the telco's 37 exchanges into a property trust and leasing them back. Telstra's minority stake is estimated to be worth around $1.5b.

Can the once market darling rescale former heights? There are plenty of reasons to believe so, and that this year's re-rating will not prove fleeting. The shares trade on around 16 times earnings, but the 'consensus' is likely still understating the fruits of the T22 plan in our view. A near 5 per cent dividend yield also looks attractive, particularly in light of recent rate cuts by central banks both sides of the Tasman.

Disclosure: Interests associated with the author hold shares in Telstra. Greg Smith is the Head of Research at investment research and funds management firm Fat Prophets.