--> Top picks: VOD, KPN, DTE & NUM. TEF remains Sell. BT d/g to Sell. Altice u/g to Buy.
Buy selectively on sector growth and cashflow recovery
European telcos out-performed in 2015 benefitting from low inflation and domestic demand in Europe, though those with EM exposure lagged. The macro advantage will wane during 2016 however and we remain downbeat on LatAm but a triumvirate of more growth, rising margins and falling capital intensity next year will see cashflow margins bounce from all time lows. A greater contribution from mobile data, market rationality and more consolidation should underpin attractive dividends. Top picks: VOD, KPN, DTE & NUM. TEF remains Sell. BT d/g to Sell. Altice u/g to Buy.
Favorable relative macro to wane in 2016 GDP growth across the European Telco footprint will improve by 0.3pp in 2016 vs. no change in 2015 and is a help, but the relative benefit to telcos of low inflation and strong domestic demand (relative to GDP) will start to wane. Further, 2016 will likely see US and UK interest rates rise and ECB tapering at least discussed which will be viewed as unhelpful for a dividend sector. Telco yields are likely to first re-rate however due to operational trends
Valuation: Toto, we’re not in Kansas any more European telcos are no longer cheap on cash flows vs market. The reason? EBITDA and capital margins that are each more than 3pp below/above their 15 year average, respectively. We expect a partial reversal in 2016 to see an OpFCF margin improvement of c20%. Further growth (our ests moved up again for 2016), operating leverage and falling capital intensity could see OpFCF margins back at 2011 levels, and the sector back to a c30% discount.
New year, new promise on mobile revenue and capex evolution Cisco forecasts annual mobile IP traffic growth (2014-19) at 59%, a rate recently experienced by the European operators. Unfortunately the OpCos experience price declines which more than outweigh the usage benefit. In a world of large volume and price changes, small deltas can make a big difference to top line trends. Our work on European data tariffs suggests that unit price deflation may soon ease with positive consequences for top lines. Our work on mobile capital intensity shows how expected capital intensity (13-14pp in Vodafone's case) can support materially higher growth trends.
More deals likely in 2016 but sector recovery not contingent upon execution Despite the Danish deal ‘disaster’ of 2015, consolidation momentum continues and we expect deals in the UK, Italy and potentially France to be consummated in 2016. We expect remedies galore including creation of new MNOs which should keep consumers protected. Whilst we see limited chance of price rises, lower risk of falls would be nevertheless helpful. Cross-border deal prospects also appear more likely with the smaller incumbents the beneficiaries of larger Co scale ambitions