The outlook for Australian telco’s

Well, one of the key takeaways from reporting season was the solid performance of the Australian Telcos. Telstra and TPG key highlights included strong underlying mobile revenue growth and improving outlook for operating costs, a focus on improving returns on invested capital and free cashflow, and also the latent value in key infrastructure assets. So based on consolidated reported revenues from Telstra, Optus and TPG mobile industry service revenue grew over 5% in the six months to June, 2024. And that growth was primarily driven by price with all operators raising prices during the period. And most tier two mobile virtual network operators are also lifting prices. Optus continues to have the lowest postpaid prices in the market, despite recently raising its front book pricing. And this really reflects its legacy back book discounts and ongoing promotional discounts for new customers given the issues it’s had over the last 18 months or so around cybersecurity and network failure. So currently Telstra’s postpaid prices are at a 10% premium to TPG and a 25% premium to Optus. But most importantly to our investment thesis is that we expect this growth in mobile revenue to continue as all operators continue to focus on generating high returns on their 5G related CapEx.

So we expect mobile pricing to remain constructive as all operators look to improve returns on that substantial network investment they’ve made. Telstra’s return on investor capital for 2024 was around 6% whilst TPGs first half, 24 return on investor capital was around 5%. And Optus for their first quarter, 25 result for the three months to June shows a return on investor capital of just 2%. And clearly these returns are well below cost of capital and need to improve. And in fact, Optus is parent company syntel said at its recent A GM. It will continue to improve operational performance through focusing on stronger pricing discipline and profitable growth, which should support free cashflow and return on invested capital. Also of relevance, TPG management has a return on investor capital component to its long-term incentives, which imply a targeted improvement of over 250 basis points over the next three years.

Of course, improving returns lead to improving free cashflow and we expect free cashflow to equity to improve across the industry. But probably the best example I can give of that is TPG, where we expect TPGs free cashflow to equity to lift from just 18 million in first half, 24 to around 450 million in FY 25 and with further improvement expected beyond that, costs are a real focus of Telstra and TPG right now. And in fact, cost saving programs have been a regular theme for Telstra since privatization and that’s really driven a significant headcount reduction over that period of time and we expect cost to be a feature of Telstra’s next five year strategic plan, particularly with AI driven benefits to be a key opportunity whilst for TPG. The first half 24 result really represented the peak of both operating costs and CapEx ahead of schedule. And TPG is now targeting a flat cost base for FY 25 with material synergies from the transformation program to substantially reduce cost further into 26 and 27 and beyond.

We also see unappreciated value in the infrastructure assets of both Telstra and TPG and for Telstra. Having made that strategic decision to retain the current ownership structure of in Preco, we think that business is really well placed for growth on a three year view and I think the market is potentially underestimating this. A key focus for Telstra is that is continued investment in fibre infrastructure and the company’s really seeing significant growth in demand underpinning that build and Telstra and Microsoft recently announced an expansion of their strategic partnership, which really underpins its inter city fibre network project, which now has five new major routes to be built and also announcement of a pilborough extension. And these projects remain on track to deliver mid-teen IRRs or better, which supports the value proposition we think. Now for TPG, the company recently confirmed its re-engagement with focus as part of its strategic review into its fiber assets. And you recall there was a prior proposal which didn’t proceed. It was tentatively valued at an EV of around 6 billion for just over 500 million of ebitda. And on that basis we believe TPG was worth over $6. Now the new deal is likely to deal with some of that complexity and we’ll likely solve for that with a smaller asset perimeter. But even if we assume a smaller asset perimeter, our valuation analysis suggests upside to at least $5 50.

So in summary, we’re attracted to the improving industry structure, the focus on improving returns and high free cashflow, which should drive high earnings and dividends, and also the underappreciated value of the infrastructure assets. Telstra remains our preferred telco and it’s a top five active weight across all our large cap strategies. At the current share price. We believe the market is undervaluing the core mobile business and the fixed infrastructure assets. We forecast Telstra to deliver EPS growth of 10% per annum over the next three years, a total shareholder return of around 15%, which of course includes the dividend of around 5% plus franking benefits. But we also like TPG, it’s also a top five active position in our income strategy. The stock has more valuation upside, albeit with greater execution risk. There are a couple of near term share price catalysts. In fact, this morning we had the ACCC clear the proposed network sharing deal with Optus and there’s also the fiber asset strategic review, which includes that potential transaction with focus, but we’re primarily attracted to TPGs improving free cashflow generation following that peak in opex and CapEx and forecast synergies. And we believe TPGs free cashflow yield is we’ll approach around 10% in around FY 27 and beyond, which is very attractive.