NZ Telecom & Communications Sector Poised to Grow amid Evolving Consumer Preferences – 4 Stocks to Consider

I. Sector Landscape and Outlook 

Ministry of Business, Innovation & Employment is responsible to provide regulatory environment for the information and communications technology (ICT) sector in New Zealand. The country is at the junction to upgrade its telecommunications infrastructure. Enhanced broadband and mobile coverage is an important component of New Zealand's economic growth, productivity improvements and broad-based strategy to compete internationally, particularly with other OECD countries. To get the ball rolling, over $2 billion in Crown funding has already been initiated in the Ultra-Fast Broadband (UFB) programme, the Rural Broadband Initiative phases 1 and 2 (RBI1 and RBI2), and the Mobile Black Spot Fund (MBSF). Meanwhile, the Information Media and Telecommunication sector reported a fall in December 2020 quarter GDP growth contribution, due to travel restrictions and slow pace of growth in the sector.

Exhibit 1: Information and Technology Sector Reported De-Growth in GDP Contribution

Data Source: stats.govt.nz, Chart Created by Kalkine Group

Growth in Fixed Broadband Usage driven by Covid-19 Pandemic

COVID-19 restrictions had positive and negative impact on the industry. The pandemic has led to growth in fixed broadband usage where average fixed broadband usage per month grew by 77GB in 2020 to 284GB that indicates a growth rate of 37% versus 15% growth in 2019.

However, international travel restrictions led to decline in total mobile roaming revenue by 15% to $96.6 million in 2020. In line with this, domestic customers roaming overseas dropped by 20% while revenue from subscribers of overseas roaming network in New Zealand rose 2% on 2019.

Importantly, total retail telecommunications revenue fell by 3.8% YoY to $5.1 billion in 2020 led by fall in mobile revenue by 3.2% YoY to $2.7 billion in 2020 and decrease in fixed network revenue of 4.0% YoY to $2.4 billion.

Exhibit 2: Continued Investment in Telecommunication Infrastructure Supported Industry Revenue

Data Source: Commerce Commission, New Zealand, Chart Created by Kalkine Group

Fibre and Fixed Wireless Broadband Continues to Grow

The country has reported a rise in fibre and fixed wireless broadband connections and as at 30 September 2020, ~1.69 million households and businesses were able to facilitate UFB fibre network with 1.05 million of them having already moved to fibre. As per Statistics New Zealand’s Household Economic Survey (HES), the average household expenses on essential household bills per month based on the most recent HES data indicates that residents spent $142 per month on telecommunications services in 2019 up from $135 in 2016.

Exhibit 3: Monthly Household Spend on Telecom Services Grew 5.2% from 2015-16 to 2018-19:

Data Source: Statistics New Zealand’s Household Economic Survey, Chart Created by Kalkine Group

Better Performance of Premium Fibre Plans

As per the release on 14 April 2021 by Commerce Commission, New Zealand, the Fibre Max Plans increased significantly following a collaboration between SamKnows and the Industry to find and fix performance limitations relating to premium fibre plans. As per the advertised speed, there is no clear dip in performance during peak hours across the country. The average download speed of Fibre Max plans has jumped by over 200 Mbps, or 35%, over previous report to around 840 Mbps. Further, Vodafone’s cable (Ultrafast HFC Max plan) is supplying speed phenomenally higher than copper technologies but ~160 Mbps lower than premium fibre plans.

Shift Towards Subscription Revenue Based Business Model in Technology Sphere

To pace with speedy demand for faster and analytical technological output, the companies in the sector are grappling for investment in R&D, which at times required additional funding, due to unavailability of in-house fund. Computer services firms account for ~27% of all business investment in R&D in New Zealand. Also, the industry is constantly investing in experienced staff, international acquisitions by NZ firms, attracting investments and funds, virtual reality, and augmented reality (VR/AR), and artificial intelligence (AI), among others.

These initiatives have also been underway to shift the business model towards subscription revenue over license fee that are huge capex for many companies (Example: Paying Microsoft a subscription rather than one-off license fees).

Exhibit 4: Revenue Model Trending Towards Subscription Model

Data Source: Ministry for Business, Innovation and Employment, Chart Created by Kalkine Group

Soaring Employment in Information Media and Telecommunications

In February 2020, there were over 7,185 firms in the Information, Media & Telecommunications sector. Over 75% of these firms had no employees, reflecting a significant proportion of self-employed workers in the sector. As MBIE, the tech sector reached $12.7 billion in total revenue that reflects a revenue growth of $972 million, the sector has 55,000 full time employees, total export were $9.4 billion, Fintech remains one of the fastest growing sectors for 5 consecutive years, and Asian growth was reported at 19.2% or $123.3 million, among other developments.

Exhibit 5: February 2020 Employee Count in Information Media & Telecommunications

Data Source: Stats NZ, Chart Created by Kalkine Group 

Index Performance:

The S&P/NZX All Information Technology (Industry Group) Index generated a 1-year return of ~85.47% as compared to ~19.21% by the S&P/NZX 50 Index.

Exhibit 6: The All Information Technology (Industry Group) outperformed NZX50 Index by whooping ~66.26% in one year period:

Source: Refinitiv (Thomson Reuters)

Key Risks and Challenges:

The high depth of innovations continues to be the top risk for the Technology, Media, and Telecommunications (TMT) industry group. This is evident from the fact that today’s technological legacy is expected to half-life in coming days unlike a decade old scenario, and any business model may become obsolete quickly. Meanwhile, to ensure minimal access to the telecommunication services by people living in remote areas, is a challenge for the sector. As providing access to these remote areas is not always economically viable and there is not much clarity on the long-term solution to this challenge.

Importantly, cyber security has been a key challenge area and the risk it holds may expand with technology upgrades like the Internet of Things and automated transport systems.

Exhibit 7: Key Risks in the Technology and Communication Services Sector:

Sources: Analysis by Kalkine Group

Outlook:

As per the release dated 9 July 2020 by International Trade Administration, Microsoft announced an investment of US$700 million to set up a data hub in New Zealand. Further, 5G has been rolled-out in Aotearoa, New Zealand (led by Vodafone NZ with Spark) and will grow throughout the country in the coming years. Meanwhile, the government’s Mobile Black Spot (MBS) infrastructure program, a part of $270 million infrastructure package announced in August 2017, is on track and is expected to be completed by 2022. Besides this, the UFB initiative, one of the largest infrastructure projects by New Zealand is expected to reach ~87% of New Zealanders, in over 390 towns and cities, able to access Fibre by the end of 2022.

Importantly, Southern Cross Cable and Spark released their Joint Venture to provide new submarine internet cable to be built between New Zealand, Australia and the United States that will be called Next and will be built by Alcatel Submarine Networks at an investment of US$350 million. Further, online video streaming subscription is widespread in New Zealand with many users turning to on-demand TV: In this, 75% of users pay for ~one streaming service, with market size in 2020 worth ~US$49 million that is expected to reach US$59 million by 2024.

Apart from the sector-specific factors, we have also analysed four NZX-listed companies operating in the same sector. This report covers their insights, outlook, performance, and potential as expected to be delivered in the near to medium term.

1) Chorus Ltd (Recommendation: Buy, Potential Upside: Low Double-Digit) (M-Cap: NZ$3.06 billion, Gross Dividend Yield: 5.012%)

Business Description:

Chorus Limited (NZX: CNU) is a telecommunication infrastructure company engaged in building and managing an open access internet network and offering broadband services.

Outlook:

Amid UFB uptake at 63% in H1FY21 from 60% in H1FY20 within completed footprints, growth in 1Gbps uptake by 21k connections, strong residential property development, monthly average data usage on fibre at 460 gigabytes, and reliability of fixed line, the company has cemented its business footprint in the market. On the back of this, the company released FY21 guidance, where EBITDA is expected to reach $640 million -$660 million and gross capex in the range of $670 million- $700 million.

Valuation Methodology: Price/Cash Flow Based Relative Valuation (Illustrative)

Note: All forecasted figures and peers have been taken from Thomson Reuters, NTM-Next Twelve Months

Stock Recommendation

We have applied Price/Cash Flow (P/CF) based relative valuation (on an illustrative basis) and the target price reflects a rise of low double-digit (in % terms). We have applied a slight premium to P/CF Multiple (NTM) (Peer Average) driven by improvement in operating cash flow, increased demand for fiber installation, and gross capex in future growth opportunities.

For the valuation purpose, we have taken peers such as Spark New Zealand Ltd (SPK.NZ), Telstra Corporation Ltd (TLS.NZ), and HKT Trust and HKT Ltd (6823.HK) to name a few.

Considering the aforesaid facts, we give a “Buy” recommendation on the stock at the current market price of $6.85 per share, up 0.88% on 29^th April 2021.

2) IkeGPS Group Ltd (Recommendation: Buy, Potential Upside: Low Double-Digit) (M-Cap: NZ$132.05 million)

Business Description:

IkeGPS Group Ltd (NZX: IKE) is a technology company that designs, sells, and deliver solutions for the collection, analysis, and management of distribution assets for electric utilities and communications companies.

Outlook

The company is focused on revenue from contract customers and expanding the same and, hence, penetrating large existing customer groups, where IKE is currently involved in analysing a small percentage of their respective assets. Importantly, the long-term driving factor for the company is the growth opportunity driven by over $350 billion investment required into fiber and 5G infrastructure in next +5 years with over 3,000 electric utility requirements by the market.

Technical Overview:

Weekly Chart

Source: Refinitiv (Thomson Reuters)

Note: Purple colour lines are Bollinger Bands® with the upper band suggesting overbought status while the lower band oversold status, and yellow lines are Fibonacci retracement lines which measure price rebound and backtrack. https://www.bollingerbands.com/

After the previous week of sell-off, the stock has given a flattish close around 38.2% retracement level of $0.998 at $0.990 for the ongoing week. The technical indicator RSI with a reading around 46 and a flattish curve at the end, suggests flat to up momentum for the stock.

Going for forward, the stock may have resistance around a 23.6% retracement level of $1.087 whereas support could be around a 50% retracement level of $0.926.

Stock Recommendation 

Considering a revival in subscription renewal rates at 87% in H1FY21, positive outlook by the management for H2FY21 (it expects to return to its trended growth profile of the prior three years), and successful completion of $19.7 million capital that was oversubscribed at institutional placement, mainly to grow sales and implementation teams, we give a “Buy” recommendation on the stock at the current market price of $0.99 per share, on 29^th April 2021.

3) Sky Network Television Limited (Recommendation: Hold, Potential Upside: Low Double-Digit) (M-Cap: NZ$303.96 million)

Business Description:

Sky Network Television Limited (NZX: SKT) through its partners in studios, sport rights, and content production acquired and created, offers on-demand subscription-based entertainment channels in sport, movies, shows, documentaries, music, and news sphere.

Outlook

The management is focused on revenue from Sky Box customer base and value addition to its customers, partners, people, and shareholders. Further, it expects organic growth in Neon and Sky Sport Now, and some recovery in Advertising and Commercial revenues in FY21. Importantly, it expects revenue in the range of $695-$715 million, EBITDA between $170- $182.5 million, NPAT between $37.5-$45.0 million, and capital expenditure in the range of $45-$55 million, in FY21.

Valuation Methodology: EV/Sales Based Relative Valuation (Illustrative)

Note: All forecasted figures and peers have been taken from Thomson Reuters, NTM-Next Twelve Months

Stock Recommendation

We have applied EV/Sales based relative valuation (on an illustrative basis) and the target price reflects a rise of low double-digit (in % terms). We have applied a slight discount to EV/Sales Multiple (NTM) (Peer Average) considering reduction in customer base, slide in advertisement revenue, and competitive demand for new service offerings from entertainment bundle that keeps a check on future growth.

For the valuation purpose, we have taken peers such as IVE Group Ltd (IGL.AX), WPP Aunz Ltd (WPP.AX), and Prime Media Group Ltd (PRT.AX) to name a few.

Considering the aforesaid facts, we give a “Hold” recommendation on the stock at the current market price of $0.174 per share, on 29^th April 2021. 

4) Gentrack Group Ltd (Recommendation: Hold, Potential Upside: Low Double-Digit) (M-Cap: NZ$151.91 million)

Business Description:

Gentrack Group Limited (NZX: GTK) designs, builds and delivers the high-performing, cloud-first revenue and provides customer experience solutions to energy and water utility companies based in UK, New Zealand, and Australia.

Outlook

The company expects FY21 EBITDA to be well below H2FY20 run rate and profitability could be reduced closer to break-even subject to the future product investment and other factors. Revenue is forecasted to be ~$100.5 million in FY21 and EBITDA at ~$5 million on the back of research and development (R&D) costs that is estimated to be ~$3 million per quarter from Q3FY21. Further, the company forecasts net cash-flow to be positive in FY21, capitalizing on the $16.8 million of net cash as of 30 September 2020.

Valuation Methodology: EV/Sales Based Relative Valuation (Illustrative)

Note: All forecasted figures and peers have been taken from Thomson Reuters, NTM-Next Twelve Months

Stock Recommendation

We have applied EV/Sales based relative valuation (on an illustrative basis) and the target price reflects a rise of low double-digit (in % terms). We have applied a slight discount to EV/Sales Multiple (NTM) (Peer Average) as the management guided that profit and cash-flow in FY21 are forecasted to be weighted to H1FY21 due to incremental R&D spend forecast for H2FY21

For the valuation purpose, we have taken peers such as Laybuy Holdings Ltd (LBY.AX), Reckon Ltd (RKN.AX), and DUG Technology Ltd (DUG.AX) to name a few.

Considering the aforesaid facts, we give a “Hold” recommendation on the stock at the current market price of $1.54 per share, up 4.76% on 29^th April 2021.

Comparative Price Chart (Source: Refinitiv (Thomson Reuters)) 

Note: Investment decision should be made depending on the investors’ appetite on upside potential, risks, holding duration, and any previous holdings. Investors can consider exiting from the stock if the Target Price mentioned as per the Valuation has been achieved and subject to the factors discussed above.

Disclaimer

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