Sid Ruttala continues his journey through the ASX20. This week his notes visit and review Telstra Corporation (TLS.ASX) and Rio Tinto (RIO.ASX).
If you have missed some of the earlier parts to Sid Ruttala's latest Talking Top Twenty, you can find them here:
Part 1: The Banks - CBA & WBC
Part 2: The Banks - NAB & ANZ
Part 3: BHP & Fortescue
Part 4: CSL & Wesfarmers
Part 5: Woolies & Macquarie
Telstra Corporation (TLS.ASX)
For those that read my previous notes on TLS, it may be quite obvious that we have conviction that this is one security that never ceases to disappoint. However, it has surprised on the upside despite some mixed results. Lets first get to the numbers, NPAT down 2.2% to $1.1bn with the biggest declines remaining across the fixed wholesale at -19.1% and, concerningly, mobile continued to disappoint adding another -12%. So why was the result a surprise? Firstly, the negative number across the fixed wholesale was to be expected given the NBN headwinds, which were factored into the share price at the time of our previous notes. Secondly, there are signs of stabilisation across the Mobile segment with service revenue remaining flat once an exclusion of hardware sales is put into the calculation. This is, in our view, the more important metric to look at in the long run.
The biggest concern when writing our previous notes was the APRU (Average Revenue Per User), which now has seemingly stabilised. That is to say, the company’s T22 strategy is paying off in not only retaining users but is heading towards an inflection point in terms of profitability per user. This is especially important within the broader context of the market; Optus’ prices increasing across all its mobile plans by ~8.15% and Vodafone-TPG likely to follow suit with a removal of their own discounts. Essentially, TLS has managed to stabilise churn and increase value with higher margins likely in future, as the market consolidates (to date the telco game has arguably been one of a race to the bottom with the intent of gaining market share).
From a cost perspective, management has again surprised on the upside with continued cost reductions, fixed costs likely to decrease by -7%, lower debt servicing costs and increased use of digital channels. Management has placed emphasis on a cost-out target of $2.2bn AUD by FY22. If this is achieved, this will be a turnaround story in terms of EBITDA going forward. In terms of the rationalisation of the business, the last big question mark was the monetisation of the infrastructure assets and management was certainly speedy in moving this forward. A new holding company, Telstra Holdco, will be established via a scheme of arrangement which will consequently hold four subsidiaries - InfraCo Fixed, InfraCo Towers, ServoCO and Telstra International. By streamlining in this way, it bodes well for the future. This remains a great move (in my view) and substantially de-risks the portfolio. In a large organisation such as TLS, having the ability to be targeted in strategy goes a long way (it will certainly show up in the numbers eventually if implemented correctly). Take, for example, Telstra International with its 3500 employees, it operates in over twenty countries stretching across the US and the Middle-East. This freedom enabling them to leverage their parent and have the invaluable ability to tailor (with independence) to the local context. By the way, Telstra International as well as Telstra Ventures (a VC arm) is where the next stage of top-line is likely to come from, the rest is a cost out story.
Red Flags & Risks: The biggest red flag when we wrote about the company six months ago was in the competitive environment. We feel that the telco market in Australia has come to a point where the market shares are likely to stay stable going forward with the big upward catalysts coming from APRU and profitability. The industry will be one of bottom line growth (not top line). As such, the competitive environment no longer remains my issue, rather the ability of management to deliver on it’s ambitious T22 strategy. This will be a cost-out story.
My Expectations: It is an interesting proposition at its current valuation, the company may have reached an inflection point and we expect a significantly better trajectory if deliverables are met going forward.
As previously mentioned, I am personally a fan of Andy Penn. Despite the headwinds, he seems to be delivering (despite what it may feel like for longstanding shareholders). For me, TLS has become a buy, assuming no further Covid headwinds.
Dividend Yield: Expected dividend yield stands at an exceptional 4.66% assuming a price of $3.44 AUD
Rio Tinto (RIO.ASX)
Before we start on the numbers for Rio specifically, I would like to place the disclaimer that I might be biased to the upside. Here are a few reasons why. No, not because I saw the price of iron ore or copper, but something else. That something else is lumber, of all things. The futures have risen from $278 USD to approximately $1380 USD in a single year. Lumber by the way goes into everything from home building to fibreglass (one of the key allocations within the Global Mobility portfolio for us). Lumber is what I personally use to confirm whether a commodity (further down the supply chain) is in a bubble or there is actually underlying the demand. It is what I call an original commodity, i.e. something we have been using for time immemorial and has either acted as a constraint or an enabler (if you’re an economist, feel free to get in touch).
All that said, at this stage the following are my assumptions: 1) There is a lot more building activity (including residential property, especially in the US); 2) The monetary and fiscal stimulus has had a requisite impact upon the market; 3) supply bottlenecks. Combine those assumptions with a fiscal stimulus across most of the planet, including the US and EU, that focuses on infrastructure, then you can understand why I remain a commodities bull at least in the medium term. So, what does this have to do with Rio you ask? Rio has a portfolio spanning basically the entirety of the supply chain, from iron ore, copper to bauxite (essential in steel production). So you could imagine why, at a $45bn market cap, I remain convinced that it is undervalued.
With that out of the way, let’s get to the numbers. Rio shipped 76Mt from the Pilbara and produced 120Kt of copper. Of these, the most important metrics to look at is the Pilbara production, which was down by -12%, comparing QoQ (less than expected but decent). Hammersley, Hope Downs and West Angelas stayed flat and in line with my expectations. Interesting to note (and in line with my broader theme upon commodities) has been sales for lower grade. This particular snippet within guidance indicates that it has been taking advantage of current pricing. Nevertheless, even with the wet weather and Escondida (expected), I was expecting more and have been rather disappointed.
Particularly interesting was the aluminium and bauxite numbers, they indicate that management has continued to be prudent with cost management. We would have liked to see some more reinvestment in the business though, especially when it comes to new copper projects or even within the Oyu Tolgoi projects. It was expected however, given the change in CEO, after last year's fiasco (i.e shareholders must be kept happy).
Red Flags & Risks: The biggest risk last year was around management and this remains the case, Stausholm remains an unknown quantity. We are yet to properly understand his priorities going forward. Nevertheless, he sits in a rather great place; commodities heading the right way and a diversified portfolio that allows him to take advantage of it. Since last year, scalps have been taken and the requisite three female board members have been added which should help overcome the PR mountain that RIO is endeavouring to conquer. More recent risks on the table are the proposed mining tax in Chile (as it currently stands the nation is looking to implement a 75% royalty on all copper mines above a price 4 USD/lb), if passed it will impact Rio’s bottom line significantly by circa. 6% from 2024 once the Escondida tax stabilization expires. Rio will need to look elsewhere to replace this flagship.
Dividend Yield: This is a capital growth story more than dividend yield. My call remains that it is a better substitute for the Banks, assuming a consistent payout ratio. The current dividend yield stands at an exceptional ~6.7% assuming a price of $118.70 AUD.
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