Improving visibility on a doubling of FCF by 2020; up to Buy, onto CL
Source of opportunity
We upgrade DT to CL-Buy from Neutral given increased visibility into its
potential to double FCF by 2020 (to >€9 bn). Our industry report published
today (Future of Fixed: The incumbent catch-up) shows how new
technologies are set to dramatically improve fixed-line access speeds over
copper. This will gradually stem the pace of DT’s domestic share loss to
cable and, in a rational market, should support a return to modest service
revenue growth without a material increase in capex. With further LT costcutting
in Germany (equivalent to 15% of current domestic EBITDA) and
strong momentum at TMUS, we forecast a 17% FCF CAGR to 2020.
Catalyst
DT’s YTD outperformance (c.10% vs. the SXKP) can be entirely explained by
the increased value of its 66% stake in TMUS. However, relative to its peers
we argue ‘core’ DT has also become more attractive: the CMD outlined new
long-term cost cutting potential (c.€1.3 bn by the early 2020s in Germany),
and it is not materially exposed to increased regulatory uncertainty on
consolidation. 3Q results are likely to be in-line with consensus, with quadplay
discounts continuing to weigh on domestic mobile (but aiding KPIs);
however our updated estimates are 4% / 10% above company-compiled
consensus EBITDA / FCF in 2016, driven by ongoing TMUS outperformance.
We are not concerned about the upcoming US spectrum auction in 1H16 –
while TMUS could spend c.$8-10 bn, we note the perpetual spectrum rights
gained are neutral to FCF and significantly accretive to mid-term growth.
Valuation
We raise our 12-month ROIC-based price target to €20 from €18.3, as we
reflect improved visibility in a higher perpetual growth rate. At our target,
DT would trade at 5.5% proportionate 2017E FCF yield / 3.5% dividend yield.
Key risks
Downside risks include competition / regulation in all markets, capital
discipline in potential long-term pan-Euro consolidation, and FX.