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Telstra – Propagate and Penetrate

For some time now it has been apparent that Telstra’s future growth will be driven by its mobile and broadband businesses. Telstra’s valuation is now dominated by these two aspects and looks set to improve as the adoption of 4G (and beyond) becomes the new standard for consumers.

Underpinning that growth is the development of better technology including new networks combined with smarter use of existing spectrum.

In this note, we unashamedly paraphrase a good piece of work written by Merrill Lynch that looks at why this new block of spectrum will continue to keep Telstra in front of its competitors for the foreseeable future, building on its recent good fortune and good execution.

Telstra purchased 40 MHz of spectrum in the last government auction of 700 MHz spectrum that provides it with the capacity it needs to maintain its momentum in mobile. Optus purchased 20 MHz while Vodafone bought none.

Cherry-picking some of Merrill Lynch’s comments:

  • Lower spectrum bands (such as 700 Mhz) are associated with wider coverage and better propagation than higher spectrum (such as the current 1800 MHz and 2100 MHz).
  • Telstra estimates that 850 MHz provides 25% more coverage than 2100 MHz at street level but that doubles when indoors.
  • In open terrain from a 30m tower, an 1800 MHz cell will cover a 16km radius while 700 MHz will cover a 24km radius.
  • Network quality is the most important factor driving loyalty to a network, more than tariffs, according to market research by Ericcson.

So, better indoor coverage and wider reach will play a key role in Telstra’s mobile network quality that will potentially sustain its momentum in mobiles.

Of course, the pricing of mobile plans, the availability of good handsets and the subsidies provided on these are also factors that will determine who wins the mobile race. But here again, Telstra is playing very hard against Optus and Vodafone so that its overall perception as the best mobile provider is not lost.

Back in May, Telstra provided an update on its mobile business. Here are some of the pertinent points to think about:

  • As at the end of December 2013, TLS had 2.95m 4G handsets, more than 400,000 tablets and 840,000 4G data devices in the market.
  • The total network covered 2.3m square kilometres and 99.3% of Australia’s population. Just out of interest, Australia’s land mass is 7.66m sq km while Germany’s is 357,021 sq km indicating the scale of Australia’s geographical challenge when it comes to mobile.
  • TLS has invested over $5.5bn in mobile since FY06.
  • TLS has more than 7,800 coverage sites.
  • Will create 8,000+ hotspots in busy social precincts such as shopping strips and business centres.
  • Investing $100m to create 2m Wi-Fi hotspots across Australia within 5 years.

Mobile already provides the largest contribution to Telstra’s operating earnings and this will only increase over the next few years as the legacy earnings continue to shrink as mobile and broadband grow.

Merrill Lynch is suggesting TLS’s mobile EBITDA will reach $4.82bn by FY16, an increase of $1.3bn over FY13, representing a compound annual growth rate of 11%.

Telstra’s net dividend yield of 5.2% (gross 7.4%) provides an additional reason to own the stock as a sensible and low risk alternative to holding cash.

Considering the implications of the Financial Services Inquiry being conducted at the moment, it might also be an opportune time to switch some investment from the bank sector into Telstra without any substantial loss of income stream (average net yield on the big four banks is 5.4%).

Remember, Telstra wants to increase its dividend as its preferred method of capital management and did so at the interim lifting the dividend to 14.5cps. The full year dividend this year should be 29cps fully franked.

The NBN remains an opportunity and a threat to Telstra, but considering the more commercial and pragmatic approach by NBN Co.’s new management (and Board) together with a more rational government suggests this is less of a concern than recent history.

Telstra should be a core portfolio stock for just about every investor.

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