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Deutsche Telekom - Dividend cut as debt mounts

Nicholas Hyett | 7 November 2019 | A A A
Deutsche Telekom - Dividend cut as debt mounts

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Deutsche Telekom AG NPV

Sell: 16.16 | Buy: 16.21 | Change -0.71 (-4.17%)
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Third quarter revenues rose 4.8% to €20bn, reflecting growth in Deutsche Telekom's US businesses and a growing mobile customer base. Underlying cash profits rose 5.4% to €6.5bn.

The 2019 dividend has been cut by 14.3% to €0.60 as the group looks to control increasing levels of debt.

The shares fell 2.7% in early trading.

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Our view

Deutsche Telekom (DT) is one of Europe's biggest telcos, and management are intent on making it bigger still.

The group's US subsidiary is looking to acquire rival network Sprint in an all-share merger. Due to the heavyweight nature of the deal, regulators have had a close eye on it. Investors shouldn't count their chickens prior to the final decision from the competition authorities, but there are several attractions to the tie-up.

Firstly, there's the benefit of scale. The combined US business would generate revenues of around $73bn and the group expects to derive close to $6bn in annual cost savings. That underpins DT's confidence that the merger would boost cash flow and profits 3 years after closing.

There are strategic reasons for merging too.

The US market has four big suppliers. AT&T, Verizon, Sprint and Deutsche Telekom's T-Mobile. T-Mobile had been last in the pecking order, but a disruptive, flexible pricing strategy helped it take significant market share. DT wants the management that oversaw that transformation to repeat the trick with the struggling Sprint business.

Spectrum licences should dovetail nicely too. Not all bandwidths are made equal, and T-Mobile doesn't have the mid-range frequencies it needs to support the roll-out of 5G nationwide. Sprint does.

We think this is a key part of the deal for DT. While there are improvements in the US and signs the group's building a popular integrated TV, phone and broadband offer in Europe, the cost of acquiring mobile spectrum is a perennial problem.

Bandwidth is sold off via auction by governments, and these outlays, which topped EUR7bn in 2017, mean free cash flow hasn't always covered the dividend. The general trend has been for spectrum prices to increase year-on-year too. That's a particular issue given what we think is a longer-running ailment of the sector, a lack of pricing power.

Debt has mounted as a result, and efforts to keep it in hand have led management to trim the dividend so that the stock now offers a prospective yield of around 3.9%. Longer-term, the group has adopted a policy of linking the payout with earnings, which could make it volatile if things don't go as planned.

While we think recent market share gains offer the potential for profits to rise, at what rate depends on the fate of the merger.

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Third Quarter Results

Revenues in the US rose 8.4% to €10bn, as the group continued to win new customers and churn remained low. The region now accounts for over half of revenues, while cash profits rose 7.9% to €2.8bn. The group now has 84.2m customers in the US, up 5.6% on the start of the year.

German revenues rose 0.6% to €5.5bn, thanks to growth in revenue from business customers and consumer mobile. Underlying cash profits rose 2.4% to €2.3bn. Fixed-line customers continue to decline, offset by strong growth in mobile, television and wholesale broadband.

The rest of Europe saw revenue rise 1% to €3.1bn, as a good growth in Greece, Austria and the Czech Republic offset weakness in Poland and Croatia. Cash profits rose 4% to €1.1bn.

Increased efficiency meant cash profits rose slightly in the IT led System Solutions business, to €144m, despite a 5.5% decline in revenues to €1.7bn. Central loses rose to €143m, while Group Development saw cash profits rise 21.2% to €269m, following the acquisition of Tele2 Netherlands.

Net debt at the end of the quarter stood at €78.8bn, 42.1% ahead of the same point last year. That's partly down to accounting changes, but also reflects spectrum acquisition costs and the cost of the dividend. Free cash before those costs rose 17.5% to €2.1bn.

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Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Thomson Reuters. These estimates are not a reliable indicator of future performance. Yields are variable and not guaranteed. Investments rise and fall in value so investors could make a loss.

This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research for more information.