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Analysts worry about Telkom debt, paint grim picture

Read time 5min 30sec
Telkom group CEO Sipho Maseko.
Telkom group CEO Sipho Maseko.

Analysts paint a grim picture of Telkom’s recovery plans following yesterday’s update that it expects a decline of 30% to 40% in headline earnings for the six months ending September.

The announcement saw Telkom lose more than R2 billion of its value on the Johannesburg Stock Exchange (JSE).

The analysts say this is the first big bump in the recovery plans of Telkom group CEO Sipho Maseko, and he will need to present a plausible and structured response to investors.

On Tuesday, Telkom, in a note to shareholders, said reported headline earnings per share and reported basic earnings per share are expected to decrease by 30% to 40% compared to the corresponding period in the prior year.

“This is due to a significant increase in net finance charges and fair value movement of 120% to 130% from R443 million reported in the prior year impacted by the International Financial Reporting Standards (IFRS16) on finance charges,” reads the note.

Profit warning

Sasfin senior portfolio manager Rob Towell says this is quite a profit warning and due to very little communication from Telkom before this, “it suggests that management did not have a handle on the scope of the finance charges and losses due to financial hedges taken out”.

He says: “Far more details should have been added to this announcement from Telkom. It will be interesting to see if they have a better handle on it by the time results come out on the 12th November. I hope they do, otherwise that debt number of R9 billion (30% of Telkom’s market cap now) is going to make investors step back and bankers step in.”

Towell believes something could have gone wrong inside Telkom.

“A race to the bottom? While great for consumers, dropping prices to rock bottom comes at a cost for businesses. Telkom has been aggressively pricing its offerings and while this has brought much-needed subscribers onboard, up to over nine million mobile users now, they come with limited profit generation.

“On the capex side, expenses continue unabated to keep the infrastructure up to date with the likes of MTN and Vodacom. When 5G arrives, that capex is going to increase exponentially; only the strongest balance sheets will be able to compete,” he explains.

As to the R2 billion loss of value suffered by the telco on the JSE yesterday, Towell says: “Telkom has done really well to turn the business around with limited capital and should be commended for it. The question now is whether they have turned the business around quick enough to be able to generate sustainable profit that will allow it to compete with the likes of MTN and Vodacom.

“This trading update is the first big bump in the recovery plans of Sipho Maseko and I do not see any recovery in the share price in the short-term. Sipho will need to have a good understanding of all the problems and present a plausible and structured response to investors come the results later in November, otherwise the great Telkom recovery might have just come to an end.”

Borrowing concerns

Another analyst, Peter Takaendesa, portfolio manager at Cape Town-based Mergence Investment Managers, says: “[Telkom] are increasing their borrowing in order to fund the mobile business as it is not generating enough cash to fund itself. It still needs to be funded either from borrowing, or to lean on the core fixed-line business’s operating cash flow and property disposals. But for now, most of that funding has been coming from borrowing.

“So the borrowing has been going up and that is really the key issue for Telkom going forward: how do they keep growing the mobile business without damaging the balance sheet?

“That’s one area the board and management have to focus on. To say how they go forward, I know they may be saying to themselves this mobile business will start generating enough cash but so far the market is not yet convinced about that because it’s still not generating enough cash to fund its expansion.

“As a result, they are paying a dividend, which is 60% of their earnings, meaning they are only retaining in the business about 40% of operating profit to fund growth. So the dividend is taking away most of the cash from their operations and the only way they have to fund the growth of their mobile business is to borrow more money from the debt market.”

Additionally, Takaendesa argues: “If they say the mobile business will, in a year or two, start to fund its own growth, I think that will be solved. However, I think before we get to that, the market is concerned the balance sheet keeps gearing and that may become an issue if something goes wrong.”

However, Takaendesa believes the R2 billion loss of value will not necessarily affect the company “because they don’t really need to raise equity in the market as their balance sheet is still okay for now”.

“I think what this has really done is put question marks in investors’ minds to say ‘we want to see more details as to what drove this earnings miss’ because it was big earning miss. You don’t come from growing earnings – they grew earnings for FY19 to March 2019 by 4% – then you come out the next six months and say ‘headline earnings are down 30-40%. It’s a big change in trend, which makes the market think what else we are missing.”

According to Takaendesa, to some extent, the market expected the finance costs to increase. “It’s only that they [costs] increased by more than what was expected but what else in the operations has not been disclosed as yet? That significant loss yesterday made people start questioning.”

Telkom’s share price nosedived by more than 8% yesterday after the announcement. At the time of publishing today, it had regained 0.82% lost ground, trading at R63.03.

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