Summary
- CAPEX expected to decline in the coming years which bodes well for FCF growth.
- The France segment's outlook is weak, with anticipated revenue and EBITDAaL decline in FY23-25, and there may be additional cost pressure due to higher wages.
- ORAN's strategic update on the Enterprise turnaround lacked specificity, with a projected two-year decline in EBITDAaL.
Summary
Overall, I think Orange SA's (ORAN) 4Q22 results were mixed. On one hand we have improving FCF profile as CAPEX is expected to decline in the coming years, which bodes well for the stock as FCF is a key metric tracked. On the other hand, Orange is going to face a weak France segment, updates on turnaround were vague, and dividends are not going to grow as fast as FCF. However, looking at the stock price movement, it is clear the market has higher preference to the increased FCF profile. Personally, I am recommending to buy ORAN on the improved FCF profile (which overweigh 2 of 3 negatives I mentioned above - dividend and turnaround updates). The current valuation (EV/forward EBITDA) is not demanding as well, give it is trading at its 10Y average.
4Q22 results
Enterprise, France, and Spain were the primary contributors to the 1.6% revenue beat in 4Q22. EBITDAaL for 4Q22 of €3,448M is in line with consensus expectations. The main highlight is that ORAN's cash flow guidance for FY23 is at least €3.5 billion, which is driven by EBITDAaL growing modestly and CAPEX is expected to see a big decline. Management's mid-term outlook for FY25 includes low single-digit growth in EBITDAaL and organic FCF of €4 billion.
Capex/FCF
When it comes to bringing fiber to people's homes, I think ORAN has done a fantastic job so far. 18 million homes have received ORAN so far, and that number is expected to peak at 20 million. The reduction of CAPEX expenditures in the future is a corollary that suggests a pick-up in FCF growth. This is consistent with management's comments made in the capital market days. Interestingly, this turned out to be a major takeaway from the company's CMD yesterday, as guidance indicate FY23 CAPEX will see a strong decline and from FY22 to FY25 there will be a €0.6 billion decline in cumulative CAPEX. As a result of the projected growth in free cash flow, there should be a greater level of trust in the ability of ORAN to maintain its dividend over the long term, while also providing the opportunity to reduce debt and make investments in future expansion plans.
France
CMD spent surprisingly little time talking about France despite expecting revenue and EBITDAaL to trend downward in FY23-25. The decline, in my opinion, could be larger than what management anticipates because of the absence of a confirmed €130 million benefit from higher regulated wholesale prices. Additionally, I expect ORAN France to face higher wage cost as well, which could sum up to hundreds of millions, assuming a mid-single-digit cost growth. In general, I am pessimistic about the France segment's outlook, and I anticipate the possibility of a downward revision to guidance if things continue to deteriorate.
Strategic update
Based on the in-depth discussion of ORAN's new operating model for Enterprise at the capital markets day, I can see that the company is putting considerable effort into the turnaround. The ultimate aim is to be seen as the go-to integrator for complex systems by potential customers. To be perfectly honest, though, I learned nothing new from the presentation. There seemed to be a lot of "headline" pointers, but not the specifics one would need to learn more about new competitive advantages. In fact, the projected two-year decline in Enterprise EBITDAaL was shown to be even steeper in the presentation than what the market was expecting. Forecasts for 2022-2024 indicate a continuation of the decline seen in EBITDAaL from 2021-2022. That would imply an EBITDAaL of roughly €600 million in 2024. Managers also noted that the guidance factors in the anticipated benefit from bolt-on cybersecurity acquisitions, raising even more questions. Overall, I have no idea what to anticipate from the Enterprise turnaround, which is bad because it expands the range of possible outcomes.
Merger
Management at ORAN is confident that the merger between ORANnge Spain and Masmovil will advance to the European Commission's Phase 2 investigation, as they believe it will benefit Spanish Telco customers. The merged entity will have a 50% stake owned by ORAN and a future option to re-consolidate by the French group.
Capital allocation
The disparity between dividend policy and cash flow projections stood out as a key aspect of the guidance provided. Between 2022 and 2025, DPS is projected to increase at a 2% CAGR, while organic telecom cash flow is forecasted to increase from €3.1 billion to €4 billion. Which, once again, management was vague about. From this, I infer that there will be a large amount of cash available for future mergers and acquisitions (which aligns with its guidance on bolt-on acquisitions). However, management did specify that it planned to use the expected proceeds from the merger with MasMovil in Spain to pay down debt rather than return the capital to shareholders.
Guidance
Management is confident that organic cash flow from telecom will hit at least €3.5 billion in 2023 and €4 billion in 2025. The assumption of low single-digit CAGR growth in EBITDAaL and stable capex at 15% of revenue appears to be supporting this.
Conclusion
In conclusion, I think ORAN is a buy as FCF is expected to improve despite ORAN's 4Q22 performance and guidance yielding mixed results. While ORAN has demonstrated impressive progress in bringing fiber to millions of homes and is expected to experience a reduction in CAPEX, there are concerns about the weak outlook for the France segment and lack of specificity around the Enterprise turnaround. That said, the current valuation is not demanding, and there is potential for the company to reduce debt and make investments in future growth. Importantly, guidance suggests an increase in free cash flow, which should help maintain the dividend over the long term.
For further details see:
Orange: Improvement In FCF Is More Important Than Anything Else