Debunking the defensive telco myth

Earnings will be impacted by USD strength.

Telcos are often viewed as defensive shelters in times of increased economic turmoil. However, Maybank Kim Eng analysts warn that these stocks are unlikely to escape unscathed on back of broad-based USD strength.

Under Maybank Kim Eng’s worst-case scenario--also known as S2--of a 10% cut in revenue, 10% FX depreciation and 100bp hike in interest rates, telco earnings will be severely impacted by the greenback’s strength.

“Under S2, all three telcos feature among the top 10-12 companies whose earnings are vulnerable to USD strength. [Free cash flow] for all three would be among the most hit by a stronger USD, given their USD-denominated imported TV content and handsets that are sold to customers at subsidised local prices,” said the report.

However, telcos should generally be more resilient to sudden revenue declines as most of their consumer and enterprise customers are locked in by long-term contracts.

A 5%/10% revenue fall would imply that many subscribers are cancelling or downgrading their mobile, broadband and pay-TV plans. This is possible only in a serious economic downturn.

“At crunch time, telcos’ high fixed operating costs such as network depreciation would work against them and their profitability and cashflows could be affected. Further, we note that retention costs tend to rise during a downturn as telcos pull out all the stops to prevent churn from rising,” said the report.