More capex and less cash generation spooks Telkom investors

Telkom’s share price fell sharply on Thursday as investors assessed the implications of faster than expected capital expenditure and a concomitant rise in debt to sustain it.

The share price fell 4.19% to close at R67.64 a share.

On Monday, the company reported what on the face of it looked like solid results for the year ending March: net operating revenue up 7.9% to R31.5 billion with headline earnings per share (Heps) rising 12.4% to R731.4 million. The group showed good growth in its mobile division (revenue up 38.4%) and information technology (revenue up 70.5%).

But on closer examination, the sharp increase in capital expenditure (capex) and negative free cash flow may have spooked investors somewhat, according to Shmuel Simpson from 36ONE Asset Management. “While the growth in the mobile segment was strong, that part of the business is smaller than the fixed line component which continues to decline. I don’t believe the market was expecting the company to accelerate capex so quickly. This implies that continued heavy investment will be required to grow profits in a challenging market.”

Tuesday’s negative GDP number would have reinforced the negative sentiment regarding the economy.

Telkom’s capital expenditure for the year rose by 43.3% to R8.6 billion. Available cash at the end of the year declined by 40.2% to R1.5 billion. According to Simpson’s numbers, Telkom incurred negative free cash flow of R137 million for the period, versus positive free cash flow of approximately R4 billion in the preceding year. That is a sharp reversal.

Simpson also indicated that management had guided the market towards a higher effective tax rate moving forward. “In the past, the company has enjoyed a lower tax rate with this year’s rate being about 15%. Management now expects this to rise closer to the statutory rate of 28% going forward, which would translate to significantly lower earnings.”

So the combination of higher capex, higher tax, lower earnings and cash generation appear to have made a nasty little cocktail. As returns are generated and investors see the tangible results of the company’s investment programme, the concerns will recede.

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