Communication Services – An Underweighted Sector in Australia?

The Telecommunications Sector or Communication Services Sector has been the best performer and was on the way towards lifting the Australian benchmark index S&P/ASX 200 to record levels on 30 July 2019. Previously, on 02 January 2019, the S&P/ASX 200 Communication Services (Sector) index (ASX: XTJ) closed at 1002.57. While, on 30 July 2019, the index mentioned above closed at 1364.19. Subsequently, it equates to a rally of 361.62 points or ~36% over the similar period. Also, on 31 July 2019, the same benchmark index closed the market session, at 1365.40, up by 1.2 points from the previous close.

XTJ Chart (Source: ASX Website)

The ASX200 index does not host a lot of names from the communication services sector. Some of the names include Chorus Limited (ASX: CNU), Speedcast International Limited (ASX: SDA), Spark New Zealand (ASX: SPK), Telstra Corporation (ASX: TLS), TPG Telecom Limited (ASX: TPM) and Vocus Group Limited (ASX: VOC).

During May 2019, the Australian Competition & Consumer Commission (ACCC) opposed the merger of TPG Telecom Limited (ASX: TPM) and Vodafone Hutchison Australia Pty Ltd. Subsequently, the regulator raised concerns stating the concentrated market in the country wherein the top three players covers the market share of over 87 per cent, which is consistent in the broadband market with a market share close to 85 per cent.

Developments

Fiscal Prudence

On 20 March 2019, the Department of Communication & the Arts announced that the Government had committed $380 million for the Mobile Black Spot Program, which would enhance the mobile coverage and competition in the country. Besides, the program has been supported by the mobile network providers including Telstra, Optus and Vodafone.

Besides, on 3 April 2019, the Department updated on the federal budget for the year 2019-20. Accordingly, the federal government had allocated $393.7 million for the country’s communication, regional media, cultural institutions and music. Interestingly, it included a $220 million package for Regional Connectivity that would ensure connectivity for the people living outside major cities. Besides, the budget was inclusive of the proposed investment under the Mobile Black Spot Program, and it also allocated $60 million for new Regional Connectivity Grants.

On 16 July 2019, the Department reported that the program has delivered over 700 mobile base stations, and these have brought to improve communication in the rural and remote parts of the country. Besides, it was reported that Telstra had activated its 600th mobile base station through the program.

On 24 July 2019, the Department of Communication & the Arts released news related to the NBN Co Limited – a government company for the broadband services in the country. Accordingly, the public outfit has reached 10 million users, and its largest ever infrastructure project would be ready by mid-2020.

Fifth Generation Network

Currently, 4G/LTE is the widely used network, and 5G supersedes the 4G or LTE. It is the latest cellular network technology. Earlier this year, according to media reports, Commonwealth Bank of Australia (ASX: CBA) tested the 5G network. Accordingly, the tests were directed to review the capabilities of 5G in traditional bank branches, and these were conducted in collaboration with Telstra and Ericsson.

It was intended to check the optimality of 5G computing, and the possible benefits over the existing capabilities. Notwithstanding, the improvements in the digital experiences of customers, which could be enhanced at the branch levels.

The Fifth-Generation network is not just capable of mere mobile communications and high-speed internet. The network could also have a drastic development on automation in the mining and farming sectors, which would be able to utilise the high bandwidth of the network in machine to machine to communication and remote controlling in irrigation farming industry.

Banning Chinese Equipment

In August 2018, the officials raised concerns over the two Chinese 5G equipment suppliers (Huawei & ZTE). A few months later, Mike Burgess, Director General of Australian Signals Directorate, had labelled the supplies from the Chinese manufacturers as highly riskier. Also, it was asserted that the future communications technology would underpin the developments for the basic needs of the citizen including water supply, health systems, electricity grids etc., and the interest of the citizens could be violated through the use of equipment from Chinese makers. Meanwhile, liberals voiced out opinions on the grounds that the business would take a hit for the companies involving from both the countries.

Recently, according to media reports, Huawei has pointed out in the Ovum report and asserted that the components of the 5G Network & radio-access network (RAN) could remain separated. Also, the report acknowledges that the core network operates the 5G network communications, which involve access, mobility, session management, data encryption and authentication. Meanwhile, RAN is utilised to convey signals between the user terminal and the core network.

Besides, the UK Government has concluded that complete banning of Huawei from 5G is not viable. However, it was said that the ban could be maintained on the core 5G network. Importantly, Huawei stated that the company is committed towards delivering the 5G technology securely, and the intention remains to initiate discussions with the Australian Government.

Let’s look at the three communication services companies:

Telstra Corporation Limited (ASX: TLS)

In May 2019, Telstra reported non-cash impairment of legacy IT assets due to the T22 strategy. Previously, the company had anticipated the non-cash impairment, which would lower the value of assets by $500 million. Besides, the company has increased its guidance on restructuring costs by $200 million.

Reportedly, the company has enabled new IT platforms under the strategic investment in digitisation announced in 2016, which allows the company to retire some legacy assets. Also, the company had notified earlier regarding the proposed job reduction, as a part of T22 strategy, which would see 8k reduction in jobs over the three years. Besides, the company intends to commence discussions on jobs with employees and unions in FY19, which was previously scheduled in the first half of FY20, and this would shift the costs from FY20 to FY19.

It was reported that the company expects to cut around 6k jobs by the end of financial year, which would allow it to meet the target of $2.5 billion in savings by 2020. Consequently, the company anticipates that the restructuring costs to increase by $200 million to $800 million.

On 31 July 2019, TLS’ stock last traded at A$3.97, up by 0.506% from the prior close.

Vocus Group Limited (ASX: VOC)

Earlier this month, Vocus Group provided a three-year turnaround strategy. MD & CEO, Kevin Russel, has asserted that the company would function through three business units with different focus and opportunities. Also, he said that the Vocus Network Services has potential and market opportunity, Vocus Retail has been impacted due to legacy voice products, low margin NBN products, and the business is in turnaround phase, Vocus New Zealand continues to be strong performer and positioned for growth.

In Vocus Network Services, the company intends to implement a comprehensive network and system overhaul, which would support the business growth, cost-optimisation and capex reduction in the next three years. Besides, it was asserted that Vocus has demonstrated the capability in completing the large-scale cable products

In Vocus Retail, it intends to establish the business as standalone along with strategy to curb profits. Besides, the company would achieve this through a transition to low cost digital operating model and automation of sales, customer care and marketing. It also expects to diversify the product portfolio to improve the revenue streams from mobiles and energy.

In Vocus New Zealand, it was asserted the company has a strong business presence in the country and the potential growth is visible to the management. Besides, it would remain focused to improve bundling across the retail offerings, tapping possible government market while optimising costs through automation.

Guidance (Source: Strategy Presentation, July 2019)

Reportedly, the company reaffirmed the guidance for FY19, and it expects underlying EBITDA to be in the range of $350 million to $370 million. Importantly, the guidance remains the same for FY20 ($350-370 million) with declines in retail to be offset by upside from network services.

On 31 July 2019, VOC’s stock last traded at A$3.23, up by 0.623% from the previous close.

TPG Telecom Limited (ASX: TPM)

Currently, TPG Telecom is amid the legal proceedings for the proposed merger with Vodafone Hutchison Australia Pty. Ltd, and the case has been lodged with the federal court. Besides, the latest announcement by the company was related to the move by Vodafone Hutchison Australia Pty. Ltd to seek nod on the merger mentioned above.

Underlying Half Year Results (Source: Half Year Presentation) 

The company has divided the revenue streams as consumer and corporate segments, and the underlying revenues from half-year results presentation indicate that consumer part accounts for a significant portion of underlying revenues. Nevertheless, the underlying EBITDA as a percentage to revenues in the corporate segment remained better off than the numbers recorded in the consumer segment.

Importantly, the consumer segment includes Broadband, Fixed Voice, Mobile, and the corporate segment includes data/internet, voice, legacy iiNet.

Over the past one- year period, the stock has recorded a return of +22.16%, and the year-to-date return stands at +11.29%. On 31 July 2019, TPM’s stock last traded at A$6.98, down by 0.286% from the previous close.


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