France Telecom (FTE-FR): Growth rater update post FY11 results – still a value trap

France Telecom (FTE-FR)
Share Price: €11.6
Target Price: €9.9
Upside: -15%
Recommendation: SELL

EVENT: FY11 results released today. Revenues were in line with consensus at €45.3bn (-1.6% underlying; -1.7% in Q4), but with near misses for EBIT (€7.9bn vs €8.3bn consensus) and EPS (€1.46 vs €1.53 consensus). EBITDA declined by an underlying -4.8% to €15.1bn (-2.8% in Q4) with margins -110bps to 33.3% (-30bps to 30.4% in Q4) with operating cash flow -9.2% lower at €9.3bn. Customer numbers advanced by +8.0%.
Company release

OUTLOOK: Weaker economic conditions, higher tax, more competition and tougher regulations. As a consequence the group expects operating cash flow in FY12 of “close to €8bn” (-14% vs FY11) with 40-45% allocated to dividends (40-47% in FY11, depending on whether minorities are included) and with no share buybacks planned.

Recommendation: SELL. The initial bounce (c.+1.5%) in the share price on these results suggests markets were already anticipating a cut in the FY12 dividend (notwithstanding that this was not reflected in analyst consensus) and that a prospective dividend yield of over 10% might still seem an attractive proposition. With €32bn of net debt however, a dividend payout of 40-45% of operating cashflow already represents the entire free cashflow of the business for FY11 and probably more than 100% of FY12’s even if the dividend is reduced in line with ‘operating cashflow’. The business meanwhile is neither growing nor expected to grow, which leaves a dividend based valuation fatally flawed. The mismatch in customer growth (of +8%) and underlying revenues (-1.6%) highlights the limited pricing power these legacy European based telcos have and while cost cutting has dulled the pain, it is not more than managed decline. On its current trajectory, we would expect the growth rating (currently over +4% CAGR) to revert the nearer the delivered underlying revenue growth, or for the business to convince the markets that this can be raised to nearer the growth currently being discounted by the share price. To do this however may require further investment with an initial cost penalty which may not be immediately applauded by markets.