NOS, S.G.P.S., S.A. (NOS) Earnings Call Transcript & Summary

Hi, good morning. Welcome to our third quarter '22 investor and analyst conference call. As usual, the full team is in the room with us today. Jose Pedro Faria da Costa, our CFO will give you a brief overview of the main highlights of the results, and then we'll be available to take your questions.

Okay. Good morning, everyone. Starting with the key highlights of the quarter. This last quarter was our best quarter this year so far in terms of commercial activity. We had around 142,000 RGU net adds, main area of growth, again being mobile, taking advantage of conversions and the 5G momentum. Overall performance is also improving in our cinema operations, with [indiscernible] revenues growing in absolute terms, it was also our best quarter post pandemic. The strong operational performance, particularly in Telco, allowed very positive financial results in the quarter with consolidated revenue growth of around 4.1%, Telco units growing 3%. Consolidated EBITDA grew 3.9% year-on-year. Telco unit posting a strong 5.1% EBITDA growth, even more impressive considering that we already have some areas with relevant inflation, namely energy. Total CapEx reached around EUR 120 million in the quarter, similar of the average of the first 2 quarters, as expected, high levels of technical CapEx explaining the year-on-year growth. And finally, free cash flow in the quarter reached EUR 150 million, benefiting from the execution of the tower deal. This strong free cash flow generation allowing us to go to 1.85x net financial debt to EBITDA AL, well below our target level of 2x. Now starting with the operational review. As we said, we have posted around 142,000 RGU net adds this last quarter. As we said, the best quarter of the year so far, growing well in all services, again, mobile performing extremely well, but also fixed growing in a robust way. Again, very strong mobile numbers. We have posted a positive 113,000 mobile net add number with 107,000 postpaid net adds and 6,000 net adds in prepaid, with conversions being the driving force behind these numbers. On the fixed area, we have posted solid fixed broadband net adds of 12,000 and also a very positive fixed Pay TV net adds of 13,000, taking advantage of increased uptake in new FTTH areas. Giving a bit more color on the convergence trends. We have added this quarter, 19,000 convergent customers and in this quarter, with 1,071,000 convergent and integrated customers, representing close to 67% of the fixed mobile. This represents over 5.5 million total convergent RGUs with net adds in the quarter of 121,000 with average number of mobile cards growing from 2.2 to 2.3 per customer, highlighting the strong results we're achieving in terms of diversification of mobile over our fixed customer base. In terms of our cinema operations, we had our best quarter in the post-pandemic period in terms of total attendance with over 1.7 million tickets sold. Still the comparison versus 2019 was not so positive as in the second quarter. Basically, as we have warned in the last call, we had a very tough comp since the third quarter of 2019 was our record ever quarter with the best performing movie ever in Portugal in terms of gross box office revenues. This, together with the movie slate for this last quarter, which was not a very strong one, led us to stay 35% below 2019 numbers in the quarter. Still the movie slate for the last quarter of this year is very promising with movies like Avatar and Black Panther. So we remain confident we will continue to recover until pre-pandemic levels. Now moving on on the B2C segment. We have continued to launch innovative offers focused on providing always the best services in the market. Following up on being the first operator and for the time being, the only operator to offer Disney+ in our top-end TV set-top boxes. We launched a special customer delight promotion to start using this OTT platform with our boxes, whereby every NOS customer can subscribe Disney+ for free for the first 3 months. Also, we have launched a new easy-to-use and affordable security service that works exclusively to our customers, protecting them against cyber security issues while being connected in our mobile and fixed networks. These first results are proving to be very, very positive. And finally, we continue to grow and increase market penetration of our new home smart security alarm service for residential and SME customers. On the B2B front, we have been leveraging our 5G hub in Lisbon, an innovation center to develop 5G use cases supported by the first stand-alone core 5G private network, one of the very few already implemented in Europe. A number of success cases have already been implemented with several key corporate customers, and we would also like to highlight some of these use cases. The first one, the augmented worker application using augmented reality, allowing more efficient remote support to field operations while reducing paper usage by switching to digital process. Also our outdoor traffic analysis application allowing to monitor traffic activity through real-time image analysis. And finally, our smart irrigation system, fully remote managed irrigation systems, supporting more efficient and rational water and energy consumption. And finally, following up on our accelerated 5G rollout, our mobile network is standing out, getting all the relevant awards in the market. Last year, we got the Ookla award for Fastest Mobile Network and Mobile Coverage. And already this year, we got the Product of the Year award for the leading mobile network, the Opensignal award for best mobile experience. Again, the Ookla award being recognized as the Fastest 5G network. And finally, the Portuguese Consumer Association Deco Proteste award us having the Best Mobile Internet Network in Portugal. On the fixed network front, our FTTH rollout continues, reaching a total of 3.1 million homes passed, that is around 59% of total coverage, almost 200,000 FTTH homes passed this last quarter. Still, most of these were what we call brownfield homes passed over our current HFC footprint. On the ESG front, we continue to make good progress on several ESG areas. We would also like to highlight a few. First, we have recently submitted our Gender Equality Plan for 2023 with diversity and inclusion initiatives update and also reaffirming, again, our objective of having 40% women in management positions. On climate-related areas, we launched again in October the campaign already implemented successfully in April, whereby during 5 days for every sale transaction, we committed to plant one tree as a result of this October campaign. We have committed to plant around 15,000 trees in addition to the 11,000 trees of the April campaign, compensating therefore, Scope 3 emissions. Also, we have revised with more ambition, our energy efficiency targets in line with our overall emission reduction targets validated by the science-based target initiative, committing to reduce energy consumption per gigabit of data traffic by 70% until 2025 and by 80% until 2030. And finally, on our digital front. It's also worth mentioning the launch of the new project ZERO1, which aims at fostering computer education for children and teams preparing them for digital features. Now moving on to the financial review on Page 17. We had again strong Group revenue growth of 4.1%, benefiting from a solid 3% growth in the Telco unit on the back of strong operational activity and also from the recovery in cinema and other visuals. We have a very positive recovery overall in terms of cinema and other visuals, having reached 23% growth. And on the Telco unit, the several segments also performed very positively. The Consumer segment posted an impressive 4.1% year-on-year growth on the back of RGU and ARPU growth, improving versus the 2.4% and 2% of last 2 quarters, showing a very positive sequential trend. B2B segment declined slightly by 2.3% in the quarter, impacted by a decline in lower margin software and equipment resale contracts, adjusted for this impact, the B2B segment would have grown slightly above 1% year-on-year, with the performance in low-end SMEs being quite positive with mid-single-digit growth in the quarter. And finally, the wholesale segment grew 9.3% year-on-year, benefiting especially from roaming in revenue recovery and also a slight increase in low-margin mass calling services. Now turning to the EBITDA line. Consolidated EBITDA in the quarter grew by 4.1%, benefiting from strong Telco EBITDA growth of 5.1% above last quarter growth, benefiting from operating leverage and also helped by cost contention efforts and efficiency gains achieved that more than compensate the inflationary pressures we're already feeling in some areas, the more relevant of which being energy. Cinema and Audio-visuals EBITDA declined by 11.9%, but this was a purely accounting impact related with the end of the transitory IFRS application during the pandemic that allowed rent discounts to be accounted above the EBITDA line. Adjusted for this impacts [ underlying ] EBITDA, you would have around 3.7%. Just a quick follow-up on energy costs. The impact of the current higher energy prices represented in the quarter around 1.5% Telco EBITDA, which should have grown 6.6% instead of the actual 5.1% if it wasn't the energy cost. Given the current challenging context, we believe our energy provisioning strategy allowed us to be today in a well-protected situation regarding the impact of the rising energy costs. We now have just about 30% of our energy consumption on the spot market. This situation is set to be maintained in the long run. The remaining energy consumption being provisioned around 50% through a 10-year PPA until 2033, contracted at very low prices and the remaining 50% being contracted through the regulated markets with controlled prices. Now moving to the net income. We have reached in this last quarter a record EUR 106 million, driven by the strong performance at the EBITDA level and of course, benefiting from the capital gain registered through the additional sites transaction, representing about EUR 75 million. We also benefited from a positive impact from our share of JV results due to the positive performance of ZAP, compensating the higher level of depreciation due to a decrease in the amortization period of terminal equipment to improve the tax efficiency. Total Group CapEx in the quarter ex-leasing reached EUR 120 million in the quarter, same level of the average of the first 2 quarters and a year-on-year increase of around EUR 10 million versus last year reflects basically an increase in Telco CapEx to around EUR 75 million in the quarter, reflecting continued FTTH rollout and particularly the 5G deployment effort and a slight increase in customer CapEx, reaching EUR 38 million, relatively similar number to the last few quarters, supported by continuing levels of churn, continuing low levels of churn and efficiency gains in areas like equipment refurbishment and self-installation. Moving to free cash flow, EBITDA minus CapEx reached a robust EUR 58 million, almost same level of last year with increasing EBITDA compensating the increase in CapEx. Free cash flow after interest and taxes generated in the quarter reached almost EUR 150 million, benefiting from the strong operational cash flow generation and in particular, by the around EUR 120 million cash in resulting from the sale of additional sites. On the tower deal, this cash-in of around EUR 120 million represents around 75% of the total cash-in related to the sale of the second package of sites communicated this last April. The remaining 25%, that is around EUR 40 million to be fully executed until year-end. And finally, on the capital structure. This free cash flow generated in the quarter allowed net financial debt to decrease to around EUR 1,000 million. This net financial debt representing 1.85x the EBITDA level adjusted for lease payments, as we said, well below our steady target of 2x. Average cost of debt was kept in the quarter, still at low levels of 1.3% level, which is expected to increase over time given the current interest rate context, still our leverage will allow us to continue benefiting from attractive spreads and cost of debt to remain at low levels relative to peers. Cash and used credit lines reached around EUR 160 million at the end of the quarter, reflecting the cash-in of the tower deal received in the last day of the quarter. And with this slide, we finish the presentation. And operator, we are now ready to start the Q&A portion.

[Operator Instructions] We'll now take our first question. This is from the line of Pilar Vico from Credit Suisse.

I have 2 on my side. So the first one is linked to the current macro environment, looking more into 2023. What is the estimated impact that we could expect from this 30% exposure to the spot rate and also the incremental impact we could expect in terms of interest costs? And the other one is more looking into EBITDA margin. I guess that this high -- higher impact of energy and supply cost will have an impact next year. But how sustainable is this high 40s figure? Should we consider these high 40s as a normalized levels going forward?

Pilar, on your first question, in terms of, let's say, overall macro environment, well, we already have some good level of inflation reflected in our numbers already. As you know, we mentioned that -- and we flagged that during the presentation, energy being the most relevant cost component in terms of cost increase. This represented overall for the first 3 quarters, close to 1.5% of total Group EBITDA, which is a relevant number. In terms of exposure to the spot market, we mentioned that today we just have this 30% exposure to the spot market, which is said to be maintained during the next few years. So we have a long-term base which basically covers around 35% of total energy consumption that runs until 2033. The rest being contracted under the regulated market. So if energy prices are set to be maintained at current very high levels, we are not expecting any significant additional inflation regarding energy for 2033. Of course, that we have other items that will be exposed to some additional inflation, namely, we have a few areas where we have contracts during 2022 that were contracted either 2020 or '21, and those were fixed during this year. So new contracts that we'll have for 2023, which are being renegotiated as we speak during '22. We'll have, of course, some level of inflation and we'll be exposed, in particular, contracts that reflect a high percentage or a high proportion of labor content. And we have a few to name in terms of field force, call centers or even our own stores in which we have outsourcing. Also what, IT outsourcing are areas in which we expect to have also some additional level of inflation for next year. But still, in terms of margins and the EBITDA margins, I don't think that, particularly you gave the example of energy, that we won't feel any additional pressure next year compared to this year. Regarding interest costs, as we refinance our debt and next year we have around EUR 350 million of that, that has to be refinanced. This new debt will be contracted at higher levels than the current debt that we have today. So we -- over time, we'll see interest costs going up, but that's something which is -- we are not the only case. So that's something you will see across all peers in the Telco industry. Still our low leverage puts us in a, I'd say, relatively comfortable position. And the spreads we are seeing today to refinance this debt are still relatively low spreads.

We'll now take the next question. This is from the line of Luigi Minerva from HSBC.

The first one is on the competitive environment and how do you see it developing going forward? There is a, obviously a track record of annual price increases. But on the other side, there is increasing pressure in terms of cost of leaving. So I'm wondering what are you seeing in terms of competitive dynamics getting into 2023? And the second question is on the FTTH strategy. So having reached 59% coverage with your own network. I mean, what is the -- what are the options now going forward for the residual part, how much will be your own build? How much can be co-investments and how much just wholesaling, other people infrastructure?

Okay. Thank you for your questions. In terms of competitive environment going into 2023, we don't expect any significant changes from what we have witnessed over these last few months, actually, more than a few. So we don't expect any developments on that front, at least until we have what is expected, which is a new operator coming into the market. But still, overall, in terms of big numbers, we don't expect competitive dynamics to significantly change as we go into 2023. In terms of FTTH, we are planning to go up to 70% of footprint covered with FTTH with our own investments, most likely shared investment under the sharing agreement that we have been executing for the last 5, 6 years. And then the remaining, we have rural areas network, which we are already using and slightly increased their footprint. We have -- we are expecting a public contest for what is called the white areas, which will be an open network to all operators. So there are a number of options to cover the remaining 30%. Some of those or most of those we will probably use third-party networks.

We'll now take our next question. This is from the line of Martin Hammerschmidt from Citi.

If I can come back to the EBITDA question, that I think Pilar was asking earlier. So I think in the first half, in the first 9 months of this year, you basically had an average growth of around 4.5% on EBITDA in the Telco business. And the way you sort of framed 2023 with limited impact of energy, maybe some wage impact, but also possibly some price increases. What would be the reason why you can't sustain sort of the 4% EBITDA increase into 2023? So that will be my first question. The second one is, in the report, sort of you expect that the underlying revenue growth in B2B was positive. Can you maybe give us a bit more color on, first of all, how you define the underlying revenues, and then how we should think about it going into 2023? Should we expect non-recurring revenue to sporadically peer numbers or is this paving essentially [ over ]? And then maybe a third question, in terms of the new entrant, the actual launch of the new entrants still might be sort of 12 months out. So what are your priorities in the meantime for your customer base? Is it sort of to push up convergence? Is it upselling customers? Is it sort of going and winning customers, i.e., so where do you place the biggest focus on at the moment in terms of customers? Just to follow on that would be great.

Okay. Thank you, Martin, for -- regarding your first question. Well, when I answered the first question, I didn't mention what type of EBITDA growth we would be targeting for 2023. I just flagged that in the case of energy, we're not expecting any additional significant headwinds versus the ones we had in 2022. I mentioned a few other areas in which we'll have inflation. But as you rightly pointed, there are other ways in which we can compensate this inflation in costs, which lead us to believe that we'll continue with the trajectory in terms of EBITDA growth. I'm not giving out at this stage any particular number, but we are confident that we should be able to continue sustaining EBITDA growth at positive levels. In terms of B2B revenues, let me just flag that we had a couple of quarters, in particular, the fourth quarter of last year and the first quarter of this year, in which we have very high non-recurrent revenues related to software and equipment resale, which are not recurrent in nature. So these quarters will have a tough comp to compare. So we will give out numbers without this resale effect. So we have to consider this in the numbers in terms of B2B projections for -- actually for the next couple of quarters in terms of year-on-year comparison. Of course, what we consider recurrent revenues are the basic revenues generated in terms of say, on the low-end SMEs in terms of connectivity services and then on the higher end corporate segment, not only the connectivity services and the connectivity revenues, but also the more IT-related revenues that are more recurrent in nature, but not this software and equipment resale, which are more volatile and lumpy.

In terms of our priorities, our focus for the next few months, they will not change dramatically. It's the same strategy we are pushing for customer base growth based on our superiority in terms of quality of service. We are pushing -- we have been pushing and still pushing for convergence. We believe that a convergent customer not only adds more value, but it's more loyal customer, which has with us a longer customer life cycle. So we are growing in mobile, as Pedro mentioned. So we are gaining market share. We continue to improve the quality of the service we provide to our customers, both in fixed with a number of initiatives in WiFi service and in mobile, both in 4G and 5G where we are clear leaders. And we will continue to push for growth beyond traditional telco boundaries in adjacent areas, both in B2C. A good example is our home security initiatives, but also in B2B with growth beyond Telco products in cloud, IT or managed services, all those different revenue streams. So we will continue to push basically the same strategy, which we believe will put us in a position and a stronger position and a much better position to hand off any new entrant.

And if I can just -- if you go back to the first question. In terms of price increases, how do you see sort of capacity to implement price increases in the market, also considering some of your competitors' reaction?

Well, if you don't mind, we would prefer not to give our opinion on price increases and possible competitor reactions, precisely for competitive reasons. So we have our views. We will take our decisions, but we are not in a position where we can share those views in public, since that could be badly understood by regulators and we don't want that to happen, we don't want to signal anything.

We'll now take our next question. Question is from the line of Clara Ng from JPMorgan.

I just wanted to follow-up on energy costs, because you've managed it quite well. Would you be able to quantify kind of the trend of the increase in H1 and in Q3. And then secondly, what else are you doing on that other than the hedging policy? Has energy consumption decreased a bit and tell a little bit more about how you're doing that? And then the second thing is on wages. Are there any wage negotiation time lines to keep in mind? And thirdly, just maybe could you share your updated thoughts, capital allocation and priorities going forward?

Okay. So thank you. On energy, I'm not sure I understood 100% your question, but let me just rephrase what I've been mentioning. So today, we have what we think is a relatively well protected situation with just 30% of energy contracted in the spot market. And this is set to be maintained during a very long period, given the way that we have structured and provisioned energy for the next few years with the PPA representing a good portion of our energy consumption. So again, we are not expecting any additional significant headwind from energy next year compared to this year. And also on the other front, I didn't mention that, but we are doing all the efforts we can to of course contain pretty much what we can in terms of the actual energy consumption. So with that in mind, we are -- we have been implementing a significant number of energy-saving measures that range from network to administrative buildings to even to our cinema units, that have also been allowing us to -- well, to contain pretty much as we can, the energy consumption levels. And in terms of efficiency, the way we measure it as energy as a percentage of the data traffic that flows in our networks. The idea is that we become more and more efficient over time. And for that purpose, we have even set more ambitious targets of reduction of 70% until 2025 and 80% to 2030. In terms of salaries negotiation, we don't have the -- what we call, the collective contract agreement. So this is a decision that we have to take on our own and that we will take in due time, but there is no negotiation with unions or any type of workers representatives for this matter.

And then capital allocation, any updated thoughts on that?

Well, capital allocation. Again, we have gone through this very intense CapEx phase, which we are now finishing. So '21 and '22, clearly, our years in terms of CapEx, '21 with the 5G spectrum licenses, '22 is the 5G deployment, '21 over EUR 500 million of CapEx, '22 with close to EUR 500 million, not reaching EUR 500 million, but on the high EUR 400 million numbers. And then over time, the idea is that we come back to the normalized levels of CapEx that you've seen in a normal period. So we should go below the EUR 400 million number next year. So normalized levels, EUR 370 million, EUR 390 million for 2023 and over time, we should be even able to go below those levels. So the idea being always to have the best technologies, the best networks in the market, but acknowledging that the most of the efforts has already been made. And also Miguel mentioned, that regarding FTTH, it will be pretty much done with close to 70% of FTTH coverage over our total footprint by the end of the fiber sharing agreement with Vodafone. So again, on that front, on the fiber front, most of the investment is already done.