TPG Telecom Ltd: Building a base

About the author:

Nick Harris
Author name:
By Nick Harris
Job title:
Senior Analyst
Date posted:
25 February 2022, 8:00 AM
Sectors Covered:
Telecommunications, Technology

  • Using PF re-stated numbers, revenue and EBITDA were down 3% yoy, while FCF was up materially. Underlying EBITDA was in line with our forecasts but higher depreciation, amortisation interest and capex meant other items were below. Management delivered a good result in a very challenging CY/FY21.
  • Momentum in the TPG business continues to improve (better synergy realisation, adding mobile customers, and the NBN drag largely done) so we expect underlying EBITDA growth in FY22. However, a number of one-off or upfront initiatives (better medium-term roaming agreements and accelerated capex) cause our short-term numbers to decline. We appreciate TPG is investing to grow the business and these outcomes will create long-term value but in the short term FCF compresses.
  • We downgrade to a Hold recommendation, for now.

Event: FY21 result

Revenue was down 3% yoy to $5.3bn; gross profit down 4% yoy to $2.8bn; OPEX up 4% yoy to $1.1bn and EBITDA down 3% yoy to $1.7bn. Statutory NPAT was down 10% yoy while Adjusted NPAT was $586m (up materially yoy but a pcp comparison wasn’t provided).

Revenue was 2% ahead of our estimate and EBITDA was 2% below. Higher depreciation, amortisation and interest meant NPAT was ~24% below and higher capex meant FCF was ~30% below our forecasts. An 8.5cps fully franked final dividend was up on 7.5cps in 2H20 vs our 8cps forecast.

Net debt (excluding finance leases) declined $122m yoy and $293m hoh. ND now sits at 2.4x LTM EBITDA, from 2.5x in FY21. At the time of the merger between Vodafone and TPG the Board set a medium-term target of 1.5-2.0x ND/EBITDA. TPG is slowly deleveraging but not as quickly as we had hoped.

Analysis: positive macro trends but higher costs hit the free cash flow

There were a number of positive signs in TPG’s result and outlook as well as the telecommunications industry in general. These suggest operating conditions and earnings should improve. However, it may take another 6-12 months for big picture trends to meaningfully flow through to operating cashflow improvements.

In addition, the key appeal for us was TPG’s attractive free cashflow, which has now been crimped.

Management has guided to FY22 and FY23 capex of around $1bn (formerly ~$800m pa). Management is understandably investing for future success but in the short term this cuts ~ 25% off our free cashflow forecasts and lowers our valuation.

There are many medium-term positives including: greater synergy realisation; upside on a return of international travel; potential to add net new FWA (alongside network upgrades); potential to add mobile customers now that TPG has consummated a roaming agreement with Telstra which improves regional coverage (subject to ACCC); and short-term potential tower monetisation.

However, following today’s result, we think any potential proceeds are more likely to be used to pay down TPG’s debt and/or fund upgraded capex spend, rather than necessarily be returned to shareholders in the form of a special dividend.

Forecast and valuation update

We reduce our Underlying EBITDA forecasts by ~1.5% in FY23/24. Higher depreciation, amortisation and interest expenses lower our numbers and we add ~$200m in FY22 expenses to switch roaming providers. Much of this is non-cash but it still substantially reduces our NPAT.

More importantly, the ~25% higher capex materially compresses our free cash flow forecasts. TPG’s FCF yield looks less attractive to us now and until we enter FY24 when capex should, hopefully dwindle.

Investment view

Our valuation declines ~15% from (login to view) and we move to a Hold.

Price catalysts

Wider launch of 5G fixed wireless services and TPG’s 5G mobile services later in CY2021. This could drive a return to mobile subscriber and ARPU growth.

A return to mobile subscriber growth when international travellers return to Australia and/or travel overseas again (Vodafone is a global brand).

Risks

Earnings stabilisation. The investment market, and ourselves, are still getting to understand TPG’s earnings base.

EPS continues to be downwardly revised.

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