TLSNF - Telia Company AB: Recommending A Hold Rating Until Turnaround Efforts Show More Positive Traction

2023-07-24 18:24:41 ET

Summary

• Telia Company AB's Q2 revenues were slightly ahead of consensus with net sales of SEK23.3 billion and organic revenue growth of 2.2%.
• The company is undergoing a restructuring process, including cutting 10-20% of its workforce.
• Despite a tough advertising environment impacting Q2 revenues, the company's focus on cost-cutting and margin maintenance is encouraging, but the risk of mis-execution in the turnaround plan could lead to investor skepticism.

Summary

Telia Company AB ( OTCPK:TLSNF ) offers telecommunication services. The Company offers mobile communications services as well as operates fixed networks throughout Eurasia. I am recommending a hold rating as I see the stock fairly valued at the current valuation, and there is a risk that turnaround efforts might not succeed.

Financials / Valuation

With net sales of SEK23.3 billion in 2Q23, TLSNF was slightly ahead of consensus. Organic revenue growth amounted to 2.2%. While one-off items reduced reported EBITDA by 1.8% to SEK7.37billion, adjusting for these revealed underlying EBITDA of SEK7.77billion. Overall, Service revenue seemed healthy at SEK19.91 billion, while TV & Media revenue was low due to declining advertising.

Based on my view of the business, if TLSNF can successfully restructure and grow as per historical trend, it should be able to grow topline in the low single digits, which combined with some margin expansion could lead to EPS growth in the 10% range (similar to the consensus estimate). I assumed a 10% discount rate, which is higher than the S&P earnings yield, as I see some risk in the restructuring efforts. My DCF model suggests a price target of SEK 21.48, implying the stock is more or less fairly valued.

Comments

Q2 revenues were down 14% year-over-year as the advertising environment in 1H23 continued to deteriorate. However, higher paytv prices contributed to a growth in Pay TV revenue. Given my belief that the advertising market will stay tough throughout the year, unless the macro economy improves, I expect this segment to continue to be sluggish. Even if the economy shows indications of improvement, it may be some time before companies are willing to spend much on advertising again. However, pricing in the TV sector should help mitigate the negative impact of the advertising downturn, so I anticipate that top-line results would be less unaffected.

The problem comes at the EBITDA line where I expect costs to remain high this year, especially with regards to labour. Consequently, TLSNF is cutting 10-20% of its workforce and attempting to reduce content costs as part of a massive restructure of the business. Management also made it plain that they are not interested in doubling down in TV media at this time. While this is encouraging news because it shows that Telia's management is focused on maintaining a healthy profit margin, the possibility that Telia could lose these rights raises doubts about the company's future growth. In my opinion, TLSNF should submit an offer that is significantly lower than what they are currently paying.

Given that the restructuring efforts are still ongoing, I expect to see the entire impact in 2024, especially as FY24 will have an easy FY23 comp. Specifically, management aims for EBITDA and cash flow to be above SEK1 billion in 2025.

For FY23, management expects a cash flow acceleration in the second half, per their guidance. In comparison to the low end of the recommended SEK 7-9 billion, the structural element of the operational cash flow was just SEK 1.4bn in 1H23. Assuming the guidance's midpoint (SEK 8 billion), TLSNF will need to generate SEK 6.6 billion in cash flow in 2H23, indicating a significant increase over 1H23. Given the increased likelihood of TLSNF missing guidance, I expect some investors to become more risk averse as a result. On the call, though, management expressed optimism about meeting the target. Management anticipates an increase in EBITDA as a result of expansion in Sweden and decreasing energy costs. H2 CAPEX will also be much lower compared to the same time last year, and particularly in Q4. I remain cautiously optimistic on this guidance and will stay at the side-lines for now.

Risk & Conclusion

The main risk I see for TLSNF is the failure of its turnaround initiatives. Since the expected earnings growth is heavily dependent on the success of this, any mis-execution in turnaround efforts would hurt the creditability of management, leading to investors shunning the stock, which will pressure the stock price. In conclusion, I recommend a hold rating for TLSNF until its turnaround efforts show more positive traction. While the stock appears to be fairly valued at the current price, the success of its restructuring initiatives is critical for future earnings growth. Q2 revenues were impacted by a tough advertising environment, but the company's focus on cost-cutting and margin maintenance is encouraging. However, the risk of mis-execution in the turnaround plan could lead to investor skepticism and stock price pressure. Until there is more evidence of successful progress, it's prudent to remain cautious and wait for further developments before making any investment decisions.

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