Cash rolls in for Telecom

By BRIAN FALLOW

Telecom has beaten analysts' forecasts, yesterday reporting net profit of $155 million in its second quarter.

But it made it clear that debt reduction continued to have first claim on its carefully husbanded cash.

Capital expenditure plans have been slashed for the second time in six months.

Shareholders need not fear for their dividends, though.

Analysts' picks for the three months to December 31 had ranged from $144 million to $152 million.

The $155 million achieved is down on the $161 million reported for the December 2001 quarter, but when adjusted for one-offs in that period was a $20 million or 15 per cent improvement, chairman Dr Rod Deane said.

In the six months to December 31 net cashflow from operations was $776 million, 50 per cent higher than in the same period the year before.

That "run rate" was not expected to be maintained for the rest of the year, Deane said, but it had enabled Telecom to reduce its net debt by $282 million (to just over $5 billion) over the half-year, $166 million of it in the December quarter.

Two ratios closely watched by the credit ratings agencies have accordingly improved: interest cover (up to 5.34 times) and gross debt to ebitda (down to 2.3 times). Ebitda is short for earnings before interest, tax, depreciation and amortisation.

But the company has some way to go before those ratios reach the ratings agencies' comfort levels of six times and two times respectively.

Deane said the company was on track to reach those targets within two years. But there is a risk the goalposts could be shifted if the ratings agencies take an even more gloomy view of the global telco sector as a whole.

Since the $850 million writedown of its Australian business six months ago Telecom's balance sheet has been lying rather low in the water: its gearing (net debt to net debt plus equity) is 77.5 per cent.

Chief financial officer Marko Bogoievski said: "The shape of our balance sheet today does not necessarily support our single-A credit rating. What we are getting from the ratings agencies, though, is a very positive endorsement about our outlook, the quality of our business and our ability to repay debt."

Chief executive Theresa Gattung said: "By and large the market is very sceptical, and has potentially given up, on telcos' getting profitable growth. So now cash generation has become very important because in a bear market that is good performance."

Telecom believed that it would return to revenue growth, that areas such as broadband would take off, but the markets did not share that view, Gattung said.

But in the meantime the changes it was making on the cost side were structural changes to the business, reducing the proportion of fixed costs.

"We do think we will return to revenue growth - though maybe not the numbers the market once thought telcos could get - but it will be with strong margins because we have changed the business model."

Accompanying the focus on debt reduction has been a dramatic reduction in capital expenditure.

In the year ended June 2002 Telecom's capex was $778 million, only half what it had been the year before.

Six months ago it expected it would at least maintain that level of capital spending, estimating $780 million for capex this year. But that was cut to $730 million three months ago and has been cut again to $650 million now.

Half of it will go to the New Zealand "wireline" business, the traditional fixed network which still generates more than half Telecom's revenue ($700 million of the $1.3 billion recorded in the December quarter) and most of its profits: $319 million of the company's total $341 million in earnings before interest and tax (ebit) in the latest quarter.

Telecom does not publish profit forecasts, but Deane said he was "not uncomfortable" with the range of analysts' forecasts for the full year, $670 million to $710 million.

An unchanged interim dividend of 5c for the quarter has been declared.

"It would be premature to consider any change to the dividend policy [to pay out 50 per cent of net earnings]," Deane said. "The primary targets are those with respect to the credit ratings agencies.

"Those targets are likely to take us 18 months to two years to achieve. Once we have achieved them we would want them to be durable, credible, sustainable and so it would only be after that point had been achieved that we would review our dividend policy."

He pointed to a recent international survey of telcos in which Telecom ranked second in terms of returns to shareholders (dividends plus share price changes) over the past year and topped it for the average of the past two years.