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Forsyth Barr

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New Zealand Professional Investment Services Firm, Forsyth Barr

Equity Bottom-Up

<h2>Chorus<br>FY20 — Appeal in an Income Scarce World&nbsp;</h2>
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<p><strong>OUTPERFORM</strong></p>
<p>There was little significant new information in Chorus's (CNU) FY20 result. Key questions remain unchanged: (1) what revenue (and therefore free cash flow [FCF]) will CNU generate under the to-be-finalised fibre regulatory regime? and (2) how will the market value CNU's FCF and dividend yield once that is determined? We estimate that from FY24 CNU will generate FCF of c.NZ70cps, which could support a sustainable dividend in the range NZ50–60cps. Despite CNU's substantial share price re-rating over the past 12 months, we see continued appeal in its (relative) value in an income-scare world. Maintain OUTPERFORM.​</p>
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<h3>Operating earnings broadly stable</h3>
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<p>CNU's revenue, down -1%, and EBITDA, up +2%, have now broadly stabilised with the growing fibre base now bigger than the declining copper one. Cost savings insulated a (relatively modest) c.NZ$12m EBITDA impact from COVID-19. CNU expects operating earnings to remain largely flat in FY21, with EBITDA guidance of NZ$640–660m (cf. FY20 NZ$648m) including a NZ$10m allowance for COVID-19 and related economic impacts. ​​​​​​​</p>
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<h3>Market remains&nbsp;focussed&nbsp;on free cash flow prize</h3>
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<p>The market continues to look forward and consider the potential significant FCF CNU will generate, and implications for the dividend, once its fibre network is complete in 2022. CNU explicitly outlined (1) it will transition to a FCF-based dividend policy from FY22, including (2) an expectation of NZ$200m pa in maintenance capex, sharply down from current fibre network rollout levels. We estimate from FY24 (when the "communal" part of the fibre network is complete) CNU will generate FCF of c.NZ70cps (albeit with partial tax paid due to depreciation tax shields), and assume a long-term sustainable dividend of c.NZ50–60cps (partly imputed). CNU has stated it may consider other capital management options and has c.NZ$225m of available subscribed capital to buy back stock tax efficiently.</p>
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<h3>Step-by-step, edging toward regulatory clarity</h3>
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<p>The most material medium-term driver of CNU's valuation remains the to-be-finalised regulatory settings and maximum allowable revenue (MAR) to be earned from its fibre network. There still remains uncertainty around the outcome, with the valuation implications magnified by CNU's high operating and financial leverage. The next key steps are the CC's publication of final input methodology decisions on 3 October and 3 November, with final clarity on the MAR still around a year away, scheduled for 2H of CY21.</p>
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<div><strong>Matt Henry CFA</strong></div>
<div><a href="mailto:matthew.henry@forsythbarr.co.nz" target="_blank" rel="noopener">matthew.henry@forsythbarr.co.<wbr>nz</a></div>
<div>+64 9 368 0115</div>
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Chorus FY20 — Appeal in an Income Scarce World&nbsp;

OUTPERFORM
There was little significant new information in Chorus's (CNU) FY20 result. Key questions remain unchanged: (1) what revenue (and therefore free cash flow [FCF]) will CNU generate under the to-be-finalised fibre regulatory regime? and (2) how will the market value CNU's FCF and dividend yield once that is determined? We estimate that from FY24 CNU will generate FCF of c.NZ70cps, which could support a sustainable dividend in the range NZ50–60cps. Despite CNU's substantial share price re-rating over the past 12 months, we see continued appeal in its (relative) value in an income-scare world. Maintain OUTPERFORM.​


Operating earnings broadly stable


CNU's revenue, down -1%, and EBITDA, up +2%, have now broadly stabilised with the growing fibre base now bigger than the declining copper one. Cost savings insulated a (relatively modest) c.NZ$12m EBITDA impact from COVID-19. CNU expects operating earnings to remain largely flat in FY21, with EBITDA guidance of NZ$640–660m (cf. FY20 NZ$648m) including a NZ$10m allowance for COVID-19 and related economic impacts. ​​​​​​​


Market remains&nbsp;focussed&nbsp;on free cash flow prize


The market continues to look forward and consider the potential significant FCF CNU will generate, and implications for the dividend, once its fibre network is complete in 2022. CNU explicitly outlined (1) it will transition to a FCF-based dividend policy from FY22, including (2) an expectation of NZ$200m pa in maintenance capex, sharply down from current fibre network rollout levels. We estimate from FY24 (when the "communal" part of the fibre network is complete) CNU will generate FCF of c.NZ70cps (albeit with partial tax paid due to depreciation tax shields), and assume a long-term sustainable dividend of c.NZ50–60cps (partly imputed). CNU has stated it may consider other capital management options and has c.NZ$225m of available subscribed capital to buy back stock tax efficiently.


Step-by-step, edging toward regulatory clarity


The most material medium-term driver of CNU's valuation remains the to-be-finalised regulatory settings and maximum allowable revenue (MAR) to be earned from its fibre network. There still remains uncertainty around the outcome, with the valuation implications magnified by CNU's high operating and financial leverage. The next key steps are the CC's publication of final input methodology decisions on 3 October and 3 November, with final clarity on the MAR still around a year away, scheduled for 2H of CY21.




Matt Henry CFA
matthew.henry@forsythbarr.co.nz
+64 9 368 0115




Chorus: FY20 — Appeal in an Income Scarce World

Chorus Ltd

Chorus: FY20 — Appeal in an Income Scarce World