Telstra's earnings guidance draws mixed response from analysts

Telstra Group (ASX: TLS) shares fell more than 4% yesterday on the back of its latest earnings guidance update and renewed projections for FY2024.

The telco giant on Tuesday revealed a $350 million cost reduction plan, including the shedding of 2,800 jobs by the end of December. These would come primarily from Telstra’s enterprise division, which provides communications services to businesses.

Telstra management also announced a change to the pricing structure within its mobile business. For post-paid mobile phone contracts, this removes its prior inflation-linked price increases.

Telstra's FY25 EBITDA guidance range of between $8.4 billion and $8.7 billion was in line with analyst expectations. Despite additional restructuring costs of between $200-$250 million, management guided toward continued growth in mobile subscribers.

Analyst reactions to the updates were mixed. Some see the removal of CPI-linked pricing as a negative due to reduced pricing visibility and increased competition. Others were positive on the increased pricing flexibility it provides.

TLS 12-month share price (Source: Market Index)

Here’s what several brokers had to say:

Macquarie

• Rating: NEUTRAL, downgraded from Outperform

• Price target: $3.70 from $4.38

“The investment thesis has changed with a more negative outlook for mobile markets. Headwinds to the dividend also an issue alongside a soft 5% div yield,” Macquarie said.

Macquarie noted Telstra’s cost reductions would be focused across its enterprise services, particularly within its network applications and services (NAS) division.

“Given the structural change to the operating structure, this could result in continued softness into FY25,” analysts said.

Mobile markets matter more

Macquarie analysts emphasised changes in Telstra’s mobile services business were more important.

“Put another way, pricing decisions are now increasingly dependent on Telstra's peers, who have had a mixed track record,” said Macquarie.

Dividends – On the back of Telstra’s announcement of one-off $200-$250 million restructuring costs. With the reduced impact on the tax paid, Macquarie analysts noted the potential negative impact on Telstra’s franking credit balance.

“As a result, we think the group will look to rectify this by keeping the dividend flat into FY25 – i.e. at 9 cps per half or 18 cps annual,” Macquarie said.

“Combined with the bond yield outlook, we think there will be some further downward pressure on the share price.”

Key risks to investment thesis

• Mobile market pricing – “Telstra has demonstrated that price increases are not without churn”

• Enterprise – With Telstra’s dominant position here, “The group is responding via price – we remain cautious on erosion of returns in this space.”

• Network applications and services (NAS) – With businesses viewing NAS products as discretionary, the softer macro environment is a negative. “Arguably, the continued transition to the cloud could benefit the top line in this business.”

• International exposure – Telstra’s Papua New Guinea business Digicel “brings…associated political/operational risks.”

• NBN retailing – “Remains highly competitive and continued margin erosion would limit another segment of profitability for the group.

Morgan Stanley

• Rating: Retain OVERWEIGHT

• Price target: $4.20, down from $4.50

Telstra’s ongoing delivery of a “progressive, rising absolute dividend” is central to Morgan Stanley’s positive investment thesis on Telstra.

“We forecast DPS 18.0 cents in FY24E, 19 cents in FY25E and 20 cents in FY26E. So, anything that puts that at risk, we are acutely focused on,” said Morgan Stanley analysts.

On the sharper falls in revenue and EBITDA within Telstra’s enterprise business, the analysts note this is a “structural not cyclical” risk. They also emphasise it is global and industry-wide rather than specific to Telstra.

Enterprise “not the full story”

Noting that Telstra’s enterprise business comprises less than 2% of their sum-of-the-parts value estimate, “that’s not the full story.”

The Morgan Stanley analysts emphasised two key lessons they've drawn from covering other businesses in structural decline, such as traditional media:

1. “Divisions with high fixed costs can potentially turn free cash flow (FCF) negative and erode shareholder value, detracting from other healthily growing businesses," and

2. “The cash wind-down costs can be expensive and absorb FCF otherwise marked for dividends/capital returns.”

They noted the need for Telstra’s response to be “decisive” – and in response have reduced their EBITDA and EPS estimates by 1-2%.

Risks to the upside

• Increased mobile market share (with gains from rival Optus now more likely), average revenue per unit (ARPU) plus higher mobile EBITDA margins

• Lift in broadband margins from cost-out and 5G fixed wireless

• Higher value for Telstra InfraCo assets (this is Telstra’s majority-owned mobile tower infrastructure business)

• Rise in DPS profile above consensus expectations.

Risks to the downside

• Technological advancements, where displacement trends continue to drive margin leakage in the Data and Connectivity business

• Industry structure change (for example, NBN)

• Competition (TPG/Vodafone and Vocus (ASX: VOC) in enterprise, TPG/Vodafone and Optus in mobile)

UBS

• Rating: BUY

• Price target: $4.40

UBS analysts were overall positive on Telstra retaining its FY24, with FY25 guidance also roughly in line.

"Cost out and headcount reduction was to be expected, given ongoing NAS review and TLS aim to push closer to its $500 million cost out target over time,” they said.

“The key surprise, however, was removal of CPI indexation clause in mobile postpaid plans as of July.”

UBS noted this increases Telstra’s flexibility on pricing – noting that Vodafone lifted prices beyond the CPI-linked price in late March/early April this year. “FY25 guidance suggests the company is expecting Mobiles to continue to be a driver of growth,” they said.

Jarden

• Rating: Retain BUY

• Price target: $4, from $4.40

On the mass job cuts, Jarden analysts said that without these, “TLS may have only achieved $50-100 million in net cost savings, compared with its original target of $500 million.”

That’s why the changes in Telstra’s mobile pricing were the biggest surprise in the update. This prompted Jarden to lower its FY25 EBITDA estimate to $8.78 billion from $8.58 billion previously.

With a view that Telstra had “conditioned” the market to expect CPI-linked price increases, the move to do away with annual CPI-linked price reviews was “a complete surprise.”

Telstra shares opened at $3.44 on Thursday.