The Aussie market may have been on a tear recently, but one sector hasn’t had any joy. Telco stocks have been absolutely left behind over the past 12 months. And it’s all thanks to the National Broadband Network (NBN).
There has been a massive transfer of value from the listed telecommunications companies to NBN Co, the company that manages the infrastructure. But it simply hasn’t been enough. The NBN simply doesn’t make enough money to justify its enormous investment.
The Australian Competition and Consumer Commission (ACCC) wants the government to do something about it. As the Financial Review reports:
‘The competition regulator has urged the federal government to rescue NBN Co, by either writing down its value so it can charge lower prices, offering relief on its debt repayments, or paying for hard-to-connect households directly through budget handouts.
‘The Australian Competition and Consumer Commission recommended the Turnbull government “consider whether NBN Co should continue to be obliged to recover its full cost of investment through its prices”, in a draft report on the communications sector released on Monday.
‘NBN Co currently collects an average $43 a month from retail service providers for each home they sell in to, but needs $52 just to recover costs, let alone fulfil the government’s expectations of a 3 per cent annualised return on its $50 billion investment in the network.’
In other words, the NBN is losing money. But because the Rudd government all those years ago mandated the building of a nearly new telecoms infrastructure that requires a commercial return to keep the expense out of the federal budget, the pricing structure is all screwed up.
It’s resulted in retail broadband margins being crushed. Previously, resellers would gain access to (usually) Telstra’s network at a wholesale price that enabled them to earn a decent retail margin.
Now, the cost of accessing the NBN is higher, but consumers aren’t willing to pay higher prices. And nor should they. Especially when in many cases the service is hardly any different to the old ADSL broadband service.
As a result, internet service suppliers are under the pump. That’s why the telco sector has underperformed so badly over the past year. The chart below shows that while the ASX 200 has increased by about 12% in 12 months, the telco index is down about 30%.
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Given Telstra [ASX:TLS] is by far the largest stock in the index, it has helped drag the sector down. But other large players like TPG [ASX:TPM] and Vocus [ASX:VOC] are also down heavily.
This wasn’t hard to see coming. In early December last year, I warned readers of Crisis & Opportunity to avoid the sector. I wrote:
‘Here’s the problem…
‘As the NBN rollout continues, more people are signing up to the network. The margins the telcos make on NBN services are much less than what they make on standard broadband services.
‘The problem is that access charges to use the NBN network are too high. And that’s because the cost of the NBN rollout has been massive. By the time it is finished (apparently around 2020, but don’t hold your breath) the capital cost will be in the vicinity of $60 billion.
‘The high access charges are an attempt to get a return on this expenditure.
‘But it won’t work, because high costs will impede the take-up of the NBN. In addition, the telcos will build their own infrastructure where they can to circumvent the NBN charges, and new wireless technology (5G) is not far away.
‘This means that there won’t be anywhere near the eight million households hooked up to the NBN that the government expects.
‘It’s an all round debacle. Quite possibly the NBN will go down as the most expensive white elephant in Australia’s history.
‘In the short term this is creating a bunch of headwinds for telco stocks. Take-up of NBN services is still growing strongly, as it’s in its early stages. With each household that switches from an old broadband service to the NBN, the retail margin falls dramatically.
‘With the recent profit announcements by TPG and VOC, this headwind has become apparent. Hence the recent sell-off in the sector.
‘But it’s also created uncertainty around the regulatory environment moving forward.
‘The way that NBN pricing is structured right now is unsustainable. It’s also reducing competition, as smaller players are unable to compete.
‘The Australian Competition and Consumer Commission are due to release a report on the state of the market early next year, as they know the current structure, if left alone, won’t produce competition.
‘On top of all this, there have been calls for the government to write off a large part of the NBN investment. Doing this will enable it to lower its access charges and still earn a decent rate of return on the lowered capital value of the project.
‘This is the most sensible outcome. But given politicians are involved, I don’t expect it to happen anytime soon.
‘Putting all this together, the industry is in a state of flux. That’s why you’re seeing share prices of the major players hitting new lows. The growth premium is coming out of the sector, and increasing uncertainty is being priced in.
‘In the short term, this means you should avoid the sector.’
I thought there might be some buying opportunities in the sector by now. But the ‘short term’ is playing out for a little longer than I expected.
With the sector down 30% since I wrote that, clearly we’re closer to the bottom. But one of my rules is not to buy into a downtrend, no matter how compelling the opportunity.
And judging by Telstra’s share price (see chart below), it’s a sector I’d advocate continuing to avoid for now.
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With a bit of luck, Telstra could be finding a bottom around here. But you want to see more evidence before guessing that is what’s happening. In other words, you want to see the share price make a ‘higher low’ to indicate the worst is over and investors are accumulating the stock at these low levels.
When ‘accumulation’ takes place, shares move into ‘stronger hands’ that will only sell at higher prices. It will be a few more months until we know whether this is the case with Telstra.
Until then, I’d continue to steer clear of telcos.
Editor, Crisis & Opportunity