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Deutsche Telekom - guidance raised

Nicholas Hyett, Equity Analyst | 12 November 2020 | A A A
Deutsche Telekom - guidance raised

No recommendation

No news or research item is a personal recommendation to deal. All investments can fall as well as rise in value so you could get back less than you invest.

Deutsche Telekom AG NPV

Sell: 17.36 | Buy: 17.42 | Change -0.11 (-0.64%)
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Deutsche Telekom's revenue grew 24.0% to €73.4bn in the first nine months of the year, mainly because of the Sprint acquisition in the US. Excluding the acquisition and the impact of exchange rates revenue grew 1.1%.

Adjusted cash profits (EBITDA AL) rose 39.4% to €26.1bn, again reflecting the impact of the acquisition. Excluding that adjusted cash profits rose 7.5%.

The group is raising guidance for full year adjusted cash profits from €34bn to at least €35bn and for free cash flow from €5.5bn to €6.0bn.

The shares were broadly flat in early trading.

View the latest Deutsche Telekom share price and how to deal

Our view

Deutsche Telekom (DTE) was already a massive telecoms provider, and the recently completed merger between T-Mobile and close rival Sprint in the US makes it bigger still. Despite being a German company, DTE makes the bulk of its revenue and profits in the US through its subsidiary T-Mobile.

The deal has much to recommend it. While Sprint's been struggling, it owns a large chunk of valuable mid-band spectrum and DTE estimates that cost savings will outweigh integration costs after three years.

However, the tie up has led Standard & Poor's, a credit ratings agency, to downgrade the group from a "BBB+" rating to "BBB ". Integrating Sprint will be costly and complicated, and Standard & Poor's expects it'll reduce free cash flow in the near term - increasing the burden of the group's substantial debt pile.

The combined group could have both the bandwidth and scale needed to take on Verizon and AT&T in the US 5G market but mergers always come with risks, especially one of this size. Either way any material benefits are unlikely to be realised before 2023.

It doesn't help that telecoms is a difficult industry to do well in.

Firstly, building and maintaining modern communications infrastructure, like towers, cables and data centres, costs a fortune. Add the ever increasing payments to governments for spectrum rights, and the capital requirements of the business become truly eye watering. In 2019 alone Deutsche Telekom spent EUR14.4bn in cash on investments and spectrum. Spectrum investment varies considerably year to year and are long term investments, so telcos typically report free cash flow excluding these payments. But they're a real cost, and investors should keep a close eye on them.

Secondly, the industry lacks pricing power. Telcos compete primarily on price, which leads to pretty feeble margins and meagre returns on the massive amounts of capital employed. This is why telcos are bundling broadband and mobile data with entertainment services and other perks, and in DTE's case Magenta TV is a big part of the offering. The idea is to offer something meaningfully different that justifies higher pricing, but it's led to something akin to an arms race.

Debt has mounted as a result, especially since the merger, and efforts to keep it in hand recently led management to trim the dividend. The stock now offers a prospective yield of around 4.1%. The group intends to pay a minimum dividend of 60 eurocents per share until 2022, although nothing is guaranteed.

We doubt investors will see much if any dividend growth until Sprint has been properly embedded, and that's conditional on the integration going smoothly.

In the medium term DTE's fortunes are largely dependent on the Sprint merger. We think the strategic rational makes sense, but executing is another matter. If all goes well the combined group could be formidable and the dividend could rise in the medium term. If not the group may struggle beneath its capital requirements and debt load.

Deutsche Telekom key facts

  • Price/Earnings ratio: 13.6
  • 10 year average Price/Earnings ratio: 15.3
  • Prospective dividend yield (next 12 months): 4.1%

All ratios are sourced from Refinitiv. Please remember yields are variable and not a reliable indicator of future income. Keep in mind key figures shouldn't be looked at on their own - it's important to understand the big picture.

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Results for the nine months ending 30 September

US revenue increased 49.0% to €44.0bn, primarily reflecting the Sprint acquisition without which revenues would have risen 1.9%. This reflects growth in both Equipment and Service revenues, mainly due to the merger. Adjusted cash profits rose 84.2% in the first half to €15.5bn despite the costs of the merger.

In Germany revenue was up 0.1% to €17.5bn, reflecting growth in fixed line broadband which offset lower mobile revenues. Consumer revenue rose 0.6% and Business revenue fell 0.8%. Adjusted cash profits rose 1.8% to €6.9bn thanks to increased revenue and lower costs.

Europe generated €8.3bn in revenue, a decrease of 1.9%. When the sale of Telekom Albania and currency movements are excluded revenue was stable. Fixed network revenues did better than mobile revenues, which struggled with lower roaming charges as a result of travel restrictions. Adjusted cash profits increased 2.1% to €3.0bn when Telekom Albania and currency are excluded, reflecting lower costs in personal, travel and marketing.

Systems Solutions generated adjusted cash profits of €173m, down 1.7% on last year. Group Development generated €836m, an increase of 8.0%.

Net debt increased €48.5bn from the end of 2019 to €124.5bn. This primarily reflects the debt acquired as part of the Sprint merger. Free cash flow before spectrum payments increase slightly to €5.3bn. Cash capital expenditure was €11.5bn before spectrum investment and €12.9bn including it.

Find out more about Deutsche Telekom shares including how to invest

This article is original Hargreaves Lansdown content, published by Hargreaves Lansdown. Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Refinitiv. 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.