ANALYST’S NOTE

Spark New Zealand (SPK) reported FY18 results that beat consensus estimates on the earnings front. Compared to the previous year, adjusted EBITDA (excluding Quantum implementation costs) was up +2.2% to $1.0bn as a result of ongoing revenue growth across mobile, cloud, security and service management and net labour cost reductions.

Group revenue was +1.0% ($35m) higher at $3.65bn, driven by significant revenue growth across mobile (+6.9%) and cloud, security and service management (+15.1%) partially offset by continuing declines in voice, managed data and networks revenues.

Adjusted NPAT was up +0.5% to $420m on prior year due to underlying EBTIDA growth, partially offset by +0.9% increase in depreciation and amortisation from a shift toward investment into shorter asset lives and finance expenses on higher average net debt. Capex was in line with the prior year at $413m – within the targeted range of 11% – 12% of operating revenues. Current net debt to EBTIDA (1.17x) continues to provide SPK with sufficient debt headroom.

Consistent with guidance given in FY17, Southern Cross dividend declined -18% to $50m, with FY19 dividend expected to decline significantly to between $10 – $20m as pre-purchase capacity from large customers decreases (FY19 DPS to be in line with FY18 at 25.0cps 75% imputed). FY19 earnings per share is expected to be between 23c – 24c (while DPS is expected to be 25.0cps as management may use debt to supplement earnings).

SPK trades in-line with our valuation and on 6.4% dividend yield; we see the stock offering stable returns and in a trading range; reiterate Neutral.

• Overall FY18 results highlights + Guidance. Group revenue increased +1.3%, and adjusted earnings (EBITDA) increased +2.2% on stable margins of 28.4%. interestingly, FY19 earnings per share is expected to be between 23c – 24c (while DPS is expected to be 25.0cps as management may use debt to supplement earnings).

By products: 1. Mobile (~35% of revenue; 38.9% market share) – saw revenue growth of +6.9%, driven by continued ARPU growth (+1.2% on prior year) and pay-monthly connection growth of +6.3% from the successful launch of an unlimited consumer mobile plan and increased migration from pre-paid to pay-monthly (Mobile gross margin up +5.3% on prior year). SPK is the only New Zealand provider to grow revenue market share, connections and ARPU during FY18. 2. Broadband (~19% of revenue; 41.5% market share) – revenue is down -0.6% on prior year. Interestingly, management noted “aggressive acquisition pricing and increases in input costs which are proving difficult to pass through” and the “market approaching saturation”. 3. Cloud, security and service management (~10% of revenue) experienced +15.1% increase in revenue growth to $373m, driven by the launch of new security products (now outpacing more labour-intensive service management products) and demand for higher-margin cloud-based services. 4. Voice and Managed Data and Networks (~5% of revenue) saw accelerating revenue decline of -12.7% and -8.2% respectively due to the ongoing shift from landline voice to other lower-margin fibre-based alternatives and ongoing competitive pricing pressures.

•  FY19 outlook…Management guided total revenue to $3,600m to $3,670m (flattish versus $3,599 in FY18), EBITDA to a range of $1,025m – $1,055m (+3.4 to +6.4% uplift above $991m in FY18), Capex at ~$410m (from $413m in FY18 and within their targeted capex at 11-12%), EPS of 23c – 24c (22.9c in FY18), and DPS in line with the prior year at 25.0cps, 75% imputed. Management aims to deliver a “total dividend that is fully funded by EPS of 25c or above” and “while EPS remain below 25c, SPK may choose to use debt to supplement earnings”.