Telstra (Credit: The New Daily)

Telstra (ASX:TLS) updated it’s FY20 guidance to account for a slower than expected rollout of the NBN. The NBN rollout is set to be a drag on the telco’s earnings over the next few years, since it is likely to materially reduce Telstra’s market share. The peak of the NBN headwind is now expected to be in 2021 instead of 2020, which helps Telstra to maintain its earnings in the interim.

Nevertheless, despite positive commentary, the actual numbers from the outlook were not particularly exciting for investors. The outlook for total income was actually downgraded by $0.4bn, while their cost reduction target was reduced by $30m. This indicates that management is less confident of their ability to cut costs within the NBN. Telstra’s share price is down over 2% on today’s news.

Telstra shares came out of a long downtrend this year, rallying 38% on the back of optimism towards their 5G rollout. As with their 4G rollout, Telstra started developing it’s 5G network earlier than competitors. While investors like companies with a strong first movers’ advantage, telco customers are not known for moving between providers quickly. Historically, there is little evidence to suggest that large numbers of customers switch service providers to access to a new network slightly earlier.

In analysing the recent rally, it is worth assessing Telstra’s 4G network, the bulk of which was rolled out in 2014 with the network completed in 2015. In 2015, the company also launched Cat-6 connectivity, a more advanced system that maximised network speed for customers and represented the pinnacle of what 4G has to offer. Since Cat-6 offered far superior connectivity, Telstra continued to rally for an extended period, as investors assessed the prospects of the network.

The share price sold off heavily once hype around 4G died, entering a multi-year downtrend. While we do not yet know the outcome for Telstra’s 5G rollout for sure, investors should think about if and why the 5G rollout will be different. The company is also a play on the US China trade war, given that the main reason Telstra is ahead on their 5G rollout is that competing networks from Optus and Vodafone have been delayed, while TPG has canned their network rollout after the Huawei Ban. It remains to be seen how long competitors will be delayed by the Huawei ban. Over the long term, any market share declines in profitable coastal cities will hit the telco’s profitability, due to the low incremental user costs of mobile networks.

With growing competition from Vodafone and TPG, investors are slowly beginning to realise that the days of a two-player telco market in Australia are over. The main cause of this is larger cities and cheaper mobile rollout costs can easily support multiple networks. Investors are pricing Telstra as though it is expected to maintain high market share at high margins, based on the company’s multiples.



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September 3, 2019