Summary
- Orange is a French telecom operator with a largely mature business.
- While its growth prospects are quite low, this is reflected in its current discounted valuation.
- It also offers a high-dividend yield that seems to be sustainable.
Orange ( ORAN ) offers a high-dividend yield that is sustainable over the coming years, making it a good income play within the European telecom sector.
Company Overview
Orange is a French telecommunications company, being the incumbent operator in its domestic market and the market’s leader. Its main shareholder is the French state, with a stake of 13.3%, which means that Orange is not likely a takeover target as the company is perceived as a ‘strategic’ company in France. Its current market value is about $28 billion, and its shares trade on the New York Stock Exchange as American Depositary Receipts (ADRs).
Geographically, its largest market is France, but it also provides mobile and fixed telecommunication services in other regions, including Europe, Africa, and the Middle East. Orange has about 280 million customers across its markets, being therefore one of the world’s leading telecom operators by this measure.
Despite its geographical diversification, Orange is still quite dependent on its domestic market, given that France accounts for about 45% of its annual revenue and more than half of its EBITDA, while the second-largest market (Spain) only accounts for some 11% of revenue and 9% of EBITDA, and other individual markets have smaller weights. Its regions with higher growth prospects over the long term are mainly Africa and Middle East, which together account for about 16% of its total revenue.
Growth & Strategy
The European telecoms market is mature and growth prospects are quite low generally, which means larger players are the ones of have more to lose against smaller players that offer more competitive packages to costumers.
This backdrop is also the market situation in France, where Orange holds a strong position due to a large market share, a position that has been challenged in the past few years. Indeed, as the French market is mature, smaller players such as Iliad ( OTC:ILIAF ) or Bouygues ( OTCPK:BOUYY ), can only gain market share by winning customers to larger operators. As the telecom market competes largely on price and service, this leads to lower prices and profitability pressure, explaining why during 2021 Orange reported a decline of 1.6% YoY on revenue, and an EBITDA decline of 2.9% YoY, in its domestic market.
To differentiate itself from competitors and enhance its competitive position, Orange’s strategy in France has been to deploy fiber network in major cities, helping it to gain fiber-to-the-home (FTTH) customers in densely populated areas. This strategy is bearing fruit, given that during the first nine months of 2022, Orange gained close to 300,000 net new customers in FTTH, on top of 350,000 new additions during 2021. This has helped Orange to increase its revenue in retail services, while wholesale has been much weaker and the main responsible for lower overall revenue in the domestic market.
In Spain, the situation is not much different, but there Telefonica ( TEF ) is the market leader and Orange had a challenger position. However, this profile is expected to change given that, a few months ago, Orange and MasMovil have reached an agreement to combine their operations in a joint-venture (50/50) valued at about €20 billion. This transaction is a game changer in the Spanish telecom market, as the combined company will become the market leader, and will boost the company’s competitiveness in the market. The closing of this transaction should happen during the first semester of 2023, and will improve Orange’s position in its second-largest market, being therefore positive for its financial performance over the next few years.
Other growth areas are mainly Africa and Middle East, where it has reported positive operating momentum in recent years, plus Orange has also made some acquisitions on other business segments, such as cybersecurity, offerings to enterprises in IT and integration services, to offset declining trends in its core telecom business. Going forward, this strategy is not expected to change much, as the telecom segment is likely to maintain muted growth prospects in mature markets and the company’s geographical footprint is not expected to change much in the foreseeable future.
Financial Performance
Regarding its financial performance , Orange has delivered a mixed performance over the past few years, given that its top-line has been relatively stable at about €41-42 billion per year over the past five years, but it has been able to report slightly higher business margins due to its efforts to reduce costs and maintain pricing discipline in its core markets.
In 2021, Orange's total revenue was €42.5 billion, representing an increase of just 0.8% YoY, as weakness in France and Spain were offset by other European countries and Africa and Middle East, which was the best segment reporting an increase of more than 10% on revenue.
While revenue was slightly up, on the other hand its EBITDA declined to €12.6 billion (-0.5% YoY) due to higher expenses related to the employee shareholding plan, leading to an EBITDA margin of 29.6% Excluding these expenses, its EBITDA would be up by 0.8% YoY, which is still not particularly impressive, but better than its reported decline in 2021.
Its reported net income was only €778 million in 2021, a strong decline compared to more than €5 billion in 2022, due to a large goodwill impairment (€3.7 billion) in Spain due to worsening competitive market environment. Excluding this one-off item, Orange’s adjusted net income was close to €4 billion, a decline of about 20% from the previous year. Its adjusted net profit margin was only 9.4%, which is not impressive, and shows that Orange needs to maintain its efforts to reduce costs and improve profitability in the coming years.
During the first nine months of 2022 , Orange’s operating performance improved slightly even though its revenue and earnings growth remained quite low. In Q3 2022, its revenue amounted to €10.8 billion (+1% YoY), while its EBITDA was €3.6 billion (+0.2% YoY). By segment, Europe (ex-France), Africa and Middle East, and Totem (its tower company) were the major growth drivers, while France (-1% YoY) remained the laggard within the group. For the full year, its guidance was for EBITDA growth of about 2.5-3% YoY, which shows a rather positive operating performance during a difficult macroeconomic environment, even though its business growth remains quite muted.
Going forward, this background is not expected to change much, considering that according to analysts’ estimates, its revenues are expected to be flat at around €43.5 billion over the next three years, while its net income is projected to grow from about €3 billion in 2022 to some €3.5 billion by 2025.
Dividends
Considering that Orange’s financial performance in the recent past and growth prospects aren’t particularly impressive, one of its most attractive factors is its high-dividend yield. Indeed, considering its annual dividend of €0.70 per share, Orange currently offers at its current share price a dividend yield of more than 7%. However, as usual with high-dividend yielders, this can either be an income opportunity or a sign that its dividend sustainability is not great.
Looking at Orange’s dividend history , the company has made a few dividend cuts in the past, and its dividend growth has been rather low, which is not a good sign regarding its future growth prospects.
In 2021, Orange paid an interim dividend of €0.30 and a final dividend of €0.40, while related to 2022 earnings it has already paid the same interim dividend and has guided for a flat final dividend, to be approved at the company’s annual general meeting in the coming months.
Considering Orange’s adjusted EPS of €1.50 in 2021, and its expected EPS of €1.12 related to 2022 earnings, its dividend seems to be well covered by earnings. Its dividend payout ratio should be around 62%, which is an acceptable level for a company like Orange that has a relatively stable and mature business profile.
Regarding its cash flow generation and balance sheet leverage, its dividend outflows have been historically covered by its free cash flow, which is a strong signal of dividend sustainability, while its net debt-to-EBITDA ratio was around 2x at the end of last June, which is in-line with the company’s target over the medium term. This means that Orange is generating enough cash to finance its dividend distributions, and its balance sheet position is adequate and Orange does not need to retain much cash, which are positive signals regarding its dividend sustainability.
Conclusion
While Orange’s financial performance has been rather weak and its growth prospects are quite muted, this seems to be already reflected in its valuation, given that it is currently trading at only 8.3x forward earnings, at a discount to its historical valuation of about 10.6x over the past five years.
Beyond that, in my opinion, the most attractive reason to buy its shares is its high-dividend yield that seems to be sustainable, being a better income pick in the European telecom sector than Vodafone ( VOD ) for instance that has weaker dividend sustainability metrics, as I’ve covered in a recent article.
For further details see:
Should You Buy Orange For Its 7% Yield?