Price squeeze easing, self-help just starting; up to CL Buy
* Source of opportunity
Iliad’s mobile launch in 2012 has driven Orange France’s EBITDA -19% and
Orange shares to de-rate by 25%. We argue that the pain is largely over: ARPU
pressure seems to have stabilised and we believe it has created a cost-cutting
culture at Orange. Labour cost flexibility remains limited, but we model Orange
delivering c.50% of the non-labour efficiencies achieved by BT and TEF after
similar profit slumps. This drives French/group EBITDA growth in 2015 and a
3% group EBITDA CAGR for 2014-18E (vs. -2% for 2011-14E). With growth
returning, a discount valuation and our assumption of a 60% probability of
French consolidation, we upgrade to Buy and add to our Conviction List.
* Catalyst
We expect consensus upgrades to drive a re-rating. In this report, we show
how two of the sector’s most impressive efficiency programmes – at BT and
TEF – have followed intense profit declines. In our base case, Orange maintains
the non-labour efficiency gains run-rate it has achieved over the last 18 months
for the next 3-4 years. This drives our 2015/16E EBITDA +4%/+8% vs. companycompiled
consensus. In a bull case, if Orange could achieve 60% of BT’s
savings, the implied share price upside would be 57% on our estimates. We
see French consolidation as likely over the next two years given that all French
operators would benefit and the French authorities are supportive. However,
the benefits to Orange would be partly offset by the loss of wholesale revenues.
*Valuation
We raise our estimates mainly to reflect French top-line stabilisation and
cost cutting. Our new ROIC-based 12-month target price is €21.1 (from
€14.0; 43% upside). Orange trades on 11% 2016E FCF yield, a 25% discount
to the sector. At our target price, its 2017E FCF yield and EV/NOPAT would
be 7% below and in line with the sector, respectively, reflecting Orange’s
similar growth outlook. It would trade at a c.10% discount to large-cap peers
Vodafone and DT on 2016 EV/NOPAT reflecting its lower revenue growth.
Key risks
Poor cost-cutting execution, competition, French consolidation delays.