Telkom SA SOC Ltd (TKG) Earnings Call Transcript & Summary

Good day, ladies and gentlemen, and welcome to the Telkom Interim Results International Analyst Call. [Operator Instructions] Please note that this call is being recorded. I'd now like to turn the conference over to Mr. Serame Taukobong. Please go ahead, sir.

Thank you kindly, madam. Good afternoon, everyone, and good morning to those in the U.S. With me, I have our Group CFO, Dirk Reyneke; and our new Head of Investor Relations Team, Babalwa George; and Keitumetse Seipelo from the Investor Relations team. I would like to unpack our internal results performance as follows: Firstly, I will start by unpacking the drivers behind the business performance that we witnessed in the first 6 months. Dirk will then unpack the group financial performance. I will come back to conclude with our strategy and operational outlook. This period was characterized by strained economic conditions, placing consumers under pressure, and an intensely competitive landscape. Group performance suffered under a sluggish economy, the increase in electricity and fuel prices, rising interest rate cycle, and high employment, which constrained and impacted levels of consumer spending. Accelerated low shedding business period also impacted our performance and our costs. As competition intensified in the mobile sector, we continue to innovate to protect Telkom's value proposition in the market. We saw good growth in our mobile subscriber base, sustained the growth trajectory in the fiber market, and corporate reviewed spending on the IT information infrastructure. We continue to pursue our migration strategy and continue to manage the transition from old to new technologies. However, this migration impacted on our revenue growth and overall profitability. Just looking at some group far and features at a high level. Group revenue was stable at ZAR 21.2 billion. We have seen good revenue growth from newer technologies. And today, the majority of our revenue comes from our NGN, next-generation networks. NGN revenues, however, are at lower margins and have impacted overall profitability. Our EBITDA reduced by 17.3% to ZAR 4.9 billion. Low shedding put further pressure on margins as our diesel costs alone increased by 154% over the period. This has impacted our cost base over the period. Dirk will provide more details on our thinking around the management of these costs. Turning our attention to the business performance. I'll now unpack how new technologies are driving growth. In Telkom Consumer, we've seen very good growth in broadband at both wholesale and retail level. Our data LIT strategy is delivering in the mobile business. The mobile customer base grew by 1.9% to over 18 million subscribers, with a limit ARPU of ZAR 8080 supported by growth of both postpaid and prepaid subscribers. Mobile broadband subscribers now represent 61.2% of our total base. This growth has also been supported by high data growth traffic of 14.1% to 550 petabytes. A bit later, Dirk will talk about how we're working to change the mix between prepaid and postpaid subscribers to drive higher levels of annuity revenue from mobile broadband subscribers. At Openserve, we see the same trends proceeding. We are expanding our fiber-to-the-home footprint, while focusing on connecting premises simultaneously. Homes past have increased by 35.8% to 951,000, while homes connected have increased by 3.7%. This has ensured that we lead with the highest connectivity rate in the country at 46.2% versus a national average ranging between 33% and 36%. Today, 73% of our fixed-line broadband customers are on next-generation technologies, being further accessed. Our hosting and provisioning of lending facilities and the ownership of our fiber pay in the Google Equiano cable system supports our mission by increasing our capacity by more than ten times. From an IT perspective, we're encouraged under BCX for the improvement in the IT market. Progress on strategic programs has resulted in healthy growth in our total IT business. Our agreement with Alibaba Cloud is part-filed over the past couple of months and is part of our plan to boost our IT business. In our masts and towers business, for Swift Net, we have increased our productive capital to 3,945 towers, with 26 new towers and 5 in bold solutions over the period. We have a healthy pipeline of limiting over 2,000 sites. I will now hand over to Dirk to take you through the group numbers in more detail.

Thank you, Serame, and hello, everybody. If we look at the group sale numbers, group service revenue on the trade with the group revenue declining minorly by 0.7%. EBITDA impacted by our higher handset costs and operational expenses. EBITDA was lower at ZAR 4.9 billion, with EBITDA margin contracting by 4.7 percentage points to 23.4%. And at carbonates interning declining significantly, headline earnings as well as basic earnings per share down 51.9% and 52.5%, respectively. We continue to invest in CapEx. CapEx allocation is still in the favor of growth areas with CapEx increasing 2.2%. All the above had the effect of increasing net debt to EBITDA level as we had to fund strategic capital requirements with free cash flow under pressure and a negative free cash flow of ZAR 1.9 billion, due mainly to the impact of prepaid postpaid mix and operating free cash flow. If I go into all of these independently, the group service revenue declined. I referred to the 0.7%. Driven by a decrease in legacy fixed voice and data as customers migrate to new technologies such as fiber and LTE. The mobile growth was supported by an increase in NGN offices in mobile and our IT business, which recorded growth of 2.3% and 16.5%, respectively. Important to note that these NGN sales are lower margins, and therefore to replace the business lost as a result of our legacy exit remains a challenge. Our strategy of repositioning the prepaid postpaid mix in the mobile business impacted revenue and free cash flow negatively, but this was intentional as this is offset by reduced acquisition costs and higher lifetime value of customers. I think, in short, people are aware of impact where we sell contract debtors and [indiscernible] defer the revenue over the period of the contract while you recognize the cost upfront. EBITDA impacted by higher exit costs. The lower EBITDA margin contracted by 4.7 percentage points. And that's attributable to a 31.4% increase in cost of handsets equipment, software and directories, following the strategy to move from prepaid to postpaid. OpEx increased by 5% year-on-year despite the leverage group increase of 6%. And therefore, we believe that the 5% increase is well below inflation or CPI of silicone. What I can see is actually good story. Included in this OpEx, there are specific out of our control expenses such as visual as a result of the current electricity shutdowns. Our diesel costs were 150% more than our diesel cost for one in the previous year. We've optimized our revenue running costs further, which contributed to an improved cost to serve in the mobile space. As we maintain stringent [indiscernible] and migrate traffic to our own network where possible. I think it's important to say what are the cost initiatives that we are currently driving. We will certainly further reduce costs in the direct cost space. And there, we think of the roaming cost, further full year benefit of the second roaming agreement with NTN for the first time. Further in the direct costs, we looked at channel optimization, and we need to move our bricks-and-mortar panel ownership model to a more franchised model and a more automated vessel channel model. And then we will address the legacy cost base on all lines. So as we move from legacy technology to next-generation technology, clearly, it should have an impact on all lines, including staff, maintenance, et cetera. So I think cost remains a topic very high on our agenda, and we will certainly prioritize that to get our total cost to revenue ratio back to the acceptable levels of 74%, 75%, rather than the 78.7% where we ended this half. If we look at capital allocation, as I said, in favor of growth areas, we continue to invest in the growth areas, namely fiber and mobile. Capital investments for the period increased by 2.2%, representing a CapEx to revenue ratio of 17.4%. You will note the swing in CapEx between fiber and mobile. Finalized, that was caused by the Spectrum costs where we bought Spectrum in March, and that was only capitalized in the first quarter of the current year. Secondly, it's driven by our fiber-to-the-home rollout, where we increased our fiber to - at reporting date - just below 1 million homes. As we speak, we probably have 1 million. It increased by 35%. We've increased our owned collective ratio by 34%, and we maintained an active fiber productivity ratio of 46.2%, which in any range mark, I think is a really good number. If we then move across to the balance sheet. You saw the net debt to EBITDA moving up to 1.7x from the 1.2x. I think in recent years, that's probably the highest it's been for a while. We still believe that that's within acceptable limits. It is, by and large, to fund the ZAR 1 billion operating profit shortfall as well as the [ ZAR 700 million to ZAR 800 million ] investment in working capital. We believe that will improve by year-end. We will probably not get back to the 1.2x, but we certainly have the opinion that the 1.7x should improve before year-end. And then lastly, in terms of free cash flow, we generated negative free cash flow of ZAR 1.9 billion as well as now the comparative period. Cash generated from operations decreased by ZAR 1.7 billion, primarily due to the ZAR 1 billion decline in profit and ZAR 860 million deterioration in cash collections. And the cash collections refers to the investment in working capital that I've just mentioned, which relates to the deferment of revenue on both handsets and debtors over the 34 to 36 months as a result of April 15. The free cash flow was partly offset by an increase in handset sales where we have taken ZAR 750 million of net sales for balance sheet. We expect to invest in our business with CapEx to revenue ratio of between 16% and 18% for the year Returning to sales has remained a key element of our capital allocation framework. And as you know, we had suspended our dividend policy 3 years ago. We will reintroduce a dividend policy when we announce our results at year-end March '23. We to continue to create value and generate positive free cash flow to reward the shareholders in the medium term, once our working capital cycle stabilizes in new demand factors and evolving customer requirements. I thank you, and will hand it back to Serame to give an update on our strategy and a bit of our look forward. Thank you, Serame.

Thank you, Dirk. Looking forward, our key theme is to accelerate NGN growth and manage costs. We do expect similar macroeconomic and market conditions in the second half of the financial year. We will drive growth in our fundamentals. All business units are focused on driving revenue growth, cost reduction, and also managing our cost base. On the consumer side, it's about driving a continued mobile broadband growth, optimizing the pre- postpaid mix, and cost-saving initiatives to manage our cost base. As the rollout of fiber and Openserve continues, we expect to see continued growth in broadband, stronger demand for backhaul - especially in the carrier and enterprise segments - equally driving cost base management and cost savings initiatives. Including the decommissioning of legacy assets, rollout of alternative power sources to mitigate the impact of a low shedding on our sites. We are also looking to optimize and reduce the reliance on diesel and enable smart building capabilities at our properties to reduce cost of utilities. BCX is expected to see sustained growth in the IT business. Product sales will be a key driver with a focus on improving mix to drive both revenue and margin growth and equally a continued focus on cost management in BCX. In Swiftnet, we'll see the performance of H2, similar to H1. The decommissioning of sites and terminations by customers, particularly one MNO, will result in growth decline from these customers. However, we continue with our new towers and in-building solutions in order to have a competitive pipeline ahead of HQ. As operators modify their network and network equipment, lease renewals and increase in fees will drive revenue growth. Margins remain steady in this business. At group level, we are fortifying our organizational structure to drive focus on execution and the delivery of our strategy. In addition, we have get ourselves up for 5G. We clearly believe that we are ready for 5G, and each business unit will be focusing on their 5G initiatives. On the 27th of October 2022, Telkom Mobile is a strong 5G network with 136 active 5G sites across 4 provinces. We are now over 160 of these active sites. Our 5G rollout is based on locations with high data demand as well as other criteria such as affordability, using our current LTE ecosystem as an indicator. Telkom Mobile's immediate focus is on providing fixed wireless access solutions. Openserve is best placed to support 5G network rollouts by all MNOs and other customers. While other means are available to facilitate 5G connectivity, in order to fully enjoy the full experience 5G promises, fiber backhaul is the backbone that connects 5G sites and thereby deliver high speed pending activity with low latencies. We feel that Openserve is strongly geared for this. BCX is co-investing with mobile in rolling out 5G sites to deliver its converged communications and IT businesses in the future. BCX will be focused on developing smart solutions for enterprise customers, including sector-focused solutions for localized private use. BCX will also invest in R&D to bring its own IP and skillsets into the market, as well as also introducing its own 5G products. In the suite of the group's 5G strategy, Swiftnet successfully launched its first 5G outdoor distribution antenna system in small sites. These sites form the basis for future site development in support of MNO's 5G rollout plans. Just to close: our strategic priorities. We remain focused on driving growth in our core business and capitalizing on our strengths. We remain steady and making good progress in our broadband leadership ambitions. Our revenue is still challenged as we manage the migration from the legacy to next-generation technologies. In order to deliver sustainable future growth, we will use adjacency to support growth. I will now share a bit more color in terms of the strategic initiatives in the first suite of unlocking our value on our strategy. We do believe that the share price does not reflect the intrinsic value. However, we are starting these journeys in ensuring that we execute the realization of this value. In Openserve, on the 1st of September, we completed the structural separation of Openserve. As part of our broadband strategy, Openserve is using capacity and scale to drive growth by expanding on existing opportunities such as commercialization and monetization of dark fiber, and also taking opportunities in emerging niche markets such as supplying backhaul smaller fiber providers. In consumer, we believe that investment in ISP will support the legacy migration process, helping us to reduce the costs associated with the management of the legacy business. In BCX, we have continuing opportunities in IT high-growth areas such as cybersecurity and cybersecurity advisory services. In Swiftnet, we are continuing to review ideal partnership options for this business that will enable us to realize value. Lastly, data is important to drive efficiencies for the group. And here, we are looking at property development partners to help us realize revenue in legacy assets. In summary, therefore, as we complete, we are confident in our strategy and will continue to invest in future data-led technologies. We will continuously look at offsetting the limited impacts of legacy revenues by replacing them with NGN. We are keeping a very close eye on our cost base and have plans in place to draw back some margin. We are utilizing our network ecosystem to build capabilities. We are pushing and driving value unlock to gain momentum. We are looking at ways to affirm and realize value in the masts and towers business. The separation of Openserve serves to open up opportunities to affirm the value of Telkom. We continue to support and accelerate core businesses with partnerships. Furthermore, we are fortifying our organizational structure to drive focus on execution and the delivery of our strategy by reorganizing ourselves with our products, services and a passion for execution. I will now hand over to the operator for any questions. Thank you.

[Operator Instructions] The first question comes from Vik Sharma from RMB Morgan Stanley.

I think my question more relates to you kind of obviously talked about building a data enabled network and yet the mobile data obviously didn't do as well. I mean there was a bit of a decline there. Did you pretty much figure out the reason? I mean, was it the competitors who kind of decline the price, so the price premium was out of that? I mean, is there a price discount relative to the competitors right now? And going forward, do you think your pricing rationalization is enough because I saw the data growth in the mobile broadband side was also quite -- was positive, and yet the revenue declined. So I think going forward, is there further rationalization that needs to happen on that pricing of data? Or do you feel comfortable in terms of the level that has been reached that possibly on here you won't be able to -- you won't be declining or kind of competing with the other competitors going forward.

I think let me try that so we are honest and open. I think if you're referring to the revenue, I think 2 things. First of all, when you look at overall revenue and we look at data combined, you will note that with the legacy, the traditional fixed state volume is where it's gone down by 11%. Your new fixed data products have gone up by 5%. If you then say, where is the legacy that's gone down, it's mostly on the managed take network services, and that's in the SMB space as well as the BCX space. But we think in terms of the NGN and other things with connectivity, that will continue to grow. So we are comfortable that as long as we monetize our fiber rollout, in other words stuck to the 46% to 50% penetration of inventory that we've built the data growth should continue.

I think just to add further. I mean, if we look at the mobile revenue, it was a tale of 2 quarters. We've managed to claw back in Q2 from a negative 3.6% to remain flat for the entire H1. So I think the trajectory is on the right way. With pricing, I think we've seen now where the other operators have landed on their pricing. We still believe that we have enough headroom to ensure that we remain competitive. We've seen this and how it responded with our postpaid tariff plans, having seen what the market activity was doing and is reflected in the growth of our postpaid base. So we do feel that from a pricing perspective, mobile can still remain competitive in the market. I hope that covers you, Vik.

The next question comes from Wessel Joubert from Oystercatcher Investments.

I've got two questions or three questions, actually. Just on the collection on the handsets. Do you guys expect to see any deterioration in handsets? Or how well do you expect that collection to go? That's the first question. The second one is, I mean, you guys are talking about getting back to the dividend policy. Looking at free cash flow and your expectations of it, how do you kind of line those 2 up? Or what would you expect to put forward? Just not, I suppose, overly generous the dividend. And then if possible, what percentage of the costs relate to the legacy businesses that are now closing down.

Wessel, let me try that. So first of all, in terms of collections of the assets, if you look at -- and we've done a detailed exercise, so I justify that on a fee basis. So first of all, we are setting off the matured and setting the contract debtors book. So once it's over 6 months in terms of tenure, we try and sell it off to the banks. We've done franchises last year, and we've done on ZAR 600 million to ZAR 700 million this year. And the banks are comfortable that the credit experience that they're getting from that end of the book is outperforming the expectation. And that's why there's appetite to buy further. And as the books mature, we will probably do another tranche of ZAR 500 million to ZAR 600 million before year-end. So that's one thing. The second thing, if you look at our data outstanding, if I look at 0 to 90 days and even up to 120 days, it ran at 63%, 64% or 65% if I look at the last 4 halves. So we don't see a significant deterioration in terms of data spending at the top end. And then thirdly, I think this is important, the scientific forward-looking IFRS 9 modeling that's done. We do our modeling and then our external auditors do their own modeling. They don't my model. I think our data that they predict in their models: they calculate a number for what the forward-looking expected loss is. And suffice to say that the variance between my and their model are very close, well within their materiality levels. So I think from a debt credit quality perspective, there's no reason to be concerned. If I understand your second question, right, it is to say free cash flow versus dividend. Let's start with free cash flow. ZAR 1.9 billion negative free cash flow for the year. I think I said it this morning, we anticipate that that should improve. Will we get to positive free cash flow in the current year? Probably not. So I cannot see us, while we're investing in fiber and while we're investing in working capital to fund the postpaid prepaid mix change that we will get into positive free cash flow territory in the current year, although the half year number should improve. And then that then links to dividends. We've been consistent in our message that we suspended our dividend policy 3 years ago. We will reintroduce a dividend policy when we announce our year-end results, our March 23 results. The dividend policy will probably be linked to cash flow. I do have a negative cash flow forecast for the year. Although you reinstitute a dividend policy doesn't automatically into a dividend declaration. The one outstanding or the one thing there that can change the game is any proceeds from value unlock is currently excluded from my cash flow forecast that I'm giving you. I hate to say that the value unlocked proceed will not trigger a special dividend. So when we get that money, the market doesn't expect a special dividend. We will use that money to first of all change the gearing of the balance sheet. And secondly, continue to invest in CapEx in the strategic growth area. And the residual will fall due to key cash flow bucket will then be considered when you look at the dividend declaration. I think the last point is percentage of costs relating to revenue. It's probably the most difficult of all the answers because on the revenue side, it's very clear that between fixed voice and line rental and traditional fixed data product is roughly ZAR 4 billion of revenue. If you say to me what is the cost directly related to that, I'm guessing a number, but it's below ZAR 1 billion. And why do I say that? It is that those are high-margin products. The infrastructure that drives that cost is repurposed. So if you take the ducting, as an example, we're now running fiber through the copper ducting. So when we stop copper deducting will not be trenched out of the ground and that cost will not go away. We've got the demand in servicing copper customers. We are currently also servicing fiber customers. So we're retraining, reskilling, and repurposing a lot of the legacy costs. So one doesn't think it's a one-on-one level. Bear with us, we've said by year-end, we will let you have pro formas based on technology. That will show you clearly what the average income versus average asset investment is for the different technologies. Those being NGN, mobile IT and legacy. I've seen those numbers for half year. We will present them at the year-end and then it will become more clear. But to split the costs directly attributable to legacy is probably the single most complicated exercise on our income statement.

[Operator Instructions] The next question comes from Madhvendra Singh from HSBC.

Just one question, actually, on your mobile network. If you could share what percentage of traffic is currently on roaming on the other mobile operators? And what percentage is carried on your own network? Thank you.

Look, I think given the nature of those contracts, we don't disclose those numbers.

Yes. Okay. I mean I was just wondering how much of the traffic actually is carried on your own network. In a sense that if you are growing your revenues, and if more traffic is carried on your own network, then there would be a link to margin improvement. Or scope to improve margins that way, if more traffic is...

Yes. Let me try and answer that differently without going into contractual breaches. If you look at when you did the first roaming agreement - I think it was in 2018 when I joined - roaming as a revenue cost, as a percentage of revenue, was sitting at 19%. If we look at where we are right now, that cost is down to less than 10%. I think about 9.1%. So that gives you a flavor that more and more of our traffic, we are keeping on our network. As Dirk highlighted, the continued expense tenuous investment in mobile to mitigate the increasing cost of driving both for loading shedding as well as ensuring that we drive more efficiency. So roaming is one of our big cost initiatives.

Serame, we lost you. Can you just repeat that?

Sorry. So what I was saying to you is that if you look at Openserve, the biggest driver of Openserve's traffic is actually the traffic that they provide for backhaul for the MNOs, the customers being Vodacom, MTN and Telkom Mobile. The key thing for us is making sure that our share of this market increases to provide longer tenure and higher value propositions.

Mr. Taukobong, at this time, we have no further questions in the queue. If I may hand over to you for closing remarks.

Thank you very much, and thank you very much, everybody, for listening. I think in essence, we are confident that our strategy of investing in future data-led technologies, we will bear fruit. We are continuously managing the impact of the decline in legacy revenue by offsetting this with NGN. As I said, we are also speeding up our value unlocked propositions to make sure that we can execute these and we'll make an announcement certainly by the year-end of certain high roads that we've made in this regard. Furthermore, as I said, we are fortifying our organizational structure to drive focus on execution and delivery of our strategy by reorganizing ourselves with our products and services, and a strong passion and focus on execution. I thank you kindly.

Thank you very much. And ladies and gentlemen, that does conclude today's teleconference. Thank you for joining us, and you may now disconnect your lines.