Can Telstra be a global technology giant?


Another year (almost) over, and assets have again been on a tear. All ASX sectors have performed well this year, with most generating double digit returns, consistent with global experience. The other global norm is the notable sectoral exception to this great performance; Telecommunications has been the laggard, underperforming by 30% through the past year as both challengers (TPG and Vocus) and incumbents (Telstra) have been outsized underperformers.

Telstra’s strategy day compounded its poor performance. In unveiling its vision as “a world class technology company”, outlining its intent to exploit new business and revenue opportunities from IoT (internet of things), 5G and big data, Telstra was no doubt reacting to the stellar performance of Technology stocks globally through 2017; in Europe up almost 20%, the US and Japan up almost 40%, and emerging markets 60%. Unfortunately, Moeen Ali can be called a spinner, but if the ball doesn’t spin … Telstra is not a global technology company, as much as it may now wish to call itself one. It is, alas, simply an inefficient, domestic, telecommunications company. Telstra’s labour costs to sales are almost 20%; TPG and Vocus are operating at half those levels, and Optus (a fairer comparator) is almost 40% lower. Spark in New Zealand has slashed its operating costs and now has labour costs to sales almost 25% lower than Telstra’s. The investor day highlighted how Telstra is forecasting record levels of ongoing mobile network capex, at almost $1.5b per annum for the next couple of years, and all industry competitors are also projected to spend at record levels. To be the high capex, high opex operator in any market is a dangerous market position as services commoditise. The market does not believe Telstra has the cultural capability to be a technology company, which together with a strategic focus upon growth rather than efficiency, has seen the share price underperform by 30% through the past year. There is an option, albeit a theoretical one at present. A refocus upon efficiency, even just by benchmarking itself to Optus, could see Telstra generate $2b in extra ebit. Telstra’s current ebit of almost $6.5b is forecast to decline to $4b in mid cycle. A $2b productivity prize on a $4b ebit base may not be alluring to the current management and Board, but as we have seen with Woolworths, and BHP, in recent years, sub optimal strategic paths are rarely allowed to continue unimpeded by capital markets for too many years, where a viable, alternative strategy exists. Brambles is another portfolio holding which has performed poorly through the past year and appears strikingly inefficient relative to peers, and where we suspect management will need to either choose to address this issue themselves or, as with Telstra, have an uninvited party offer to assist them to this end.

Whilst Telstra and Brambles have not had any growth in recent years, the truth is the market hasn’t had any material earnings growth either. Through the past several years, market eps growth only broached 5% once (in 2017), and even then this was simply because Resources had a large contribution following a poor year in 2016. Industrials eps growth hasn’t exceeded 4% any year in the past cycle, and Bank eps growth is roughly half that level on average. Over the longer term, Resources are second only to Healthcare in terms of eps growth for ASX sectors. We suspect eps growth forecasts shall again prove optimistic in 2018 and 2019, and ultimately achieved levels of eps growth will be sub 5%, akin to that seen through the past several years.