Telstra Corporation. Vodafone better, but far from good A$6.43 AUSTRALIA. Event. Impact. Earnings and target price revision.

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1 AUSTRALIA TLS AU Price (at 11:23, 21 Jul 2015 GMT) Neutral A$6.43 Valuation A$ DCF (WACC 6.8%, beta 0.8, ERP 5.0%, RFR 3.8%, TGR 1.2%) 12-month target A$ month TSR % +3.3 Volatility Index Low GICS sector Telecommunication Services Market cap A$m 78, day avg turnover A$m Number shares on issue m 12,226 Investment fundamentals Year end 30 Jun 2014A 2015E 2016E 2017E Revenue m 25,320 25,521 26,896 27,148 EBIT m 6,656 6,571 6,867 6,875 Reported profit m 4,275 4,141 4,872 5,545 Adjusted profit m 3,970 4,002 4,142 4,202 Gross cashflow m 7,990 8,109 8,349 8,383 CFPS CFPS growth % PGCFPS x PGCFPS rel x EPS adj EPS adj growth % PER adj x PER rel x Total DPS Total div yield % Franking % ROA % ROE % EV/EBITDA x Net debt/equity % P/BV x TLS AU vs ASX 100, & rec history Note: Recommendation timeline - if not a continuous line, then there was no Macquarie coverage at the time or there was an embargo period. Source: FactSet, Macquarie Research, July 2015 (all figures in AUD unless noted) 21 July 2015 Macquarie Securities (Australia) Limited Vodafone better, but far from good Event Hutchison Telecom Australia has released its 1H15 results to the ASX, providing insights into the trading of Vodafone Hutchison Australia (VHA). While there are some improvements in the operating trajectory for Vodafone, the financials continue to paint the picture of a business that is under pressure. Impact Vodafone s subscriber trends remain weak, with the number three mobile operator losing 47k network customers in the half. This was reflective of MVNO customer losses, with Vodafone brands adding 6k in the period. Postpaid subscriber momentum out-paced pre-paid, which reflects competition in the pre-paid space as well as seasonal impacts. Service revenues fell 1.1% in the half, an improvement from the 8.9% decline in CY2014. The turnaround is largely due to a stabilisation in subscriber numbers, and improvement in ARPU trends. ARPU improvement relates to mix shift (growth in post-paid subscribers), and also greater take-up of higher end Red plans (post-paid). The trend to higher base post-paid plans is consistent with recent commentary and reporting from Optus and Telstra, reflecting increased demand for data, increased handset spend following the release of iphone 6, and following the rollout of 4G networks. We estimate Vodafone EBITDA fell 14% in the period, due primarily to the reinvestment in the business through customer service initiatives, content bundling, an expanded retail presence and increased handset sales/subsidies. The business looks like it continues to annualise at $ m of EBITDA, which wouldn t cover much more than the capex requirements of the business. Significant debts (mostly shareholder loans) drove a $183m loss for the VHA JV during the half. From an industry perspective, these numbers are consistent with what we already know. While Vodafone is reinvesting in its business and has seen some stabilisation in trends, it remains in a delicate financial position overall. As long as this is the case, it is unlikely to pursue aggressive customer acquisition strategies in the core Consumer market that would only further pressure near-term financials. Having said that, Vodafone has this week flagged a very aggressive pricing position in the SME market where it has just a 6% share currently and hence little to lose. Earnings and target price revision No change to Telstra numbers following this update. Price catalyst 12-month price target: A$6.30 based on a DCF methodology. Catalyst: FY15 result (13 August). Action and recommendation Retain Neutral recommendation for Telstra, with a TP of $6.30/sh. Telstra faces increasing competition; however a robust earnings outlook and ramp-up in NBN cashflow should underpin the share price near current levels. Please refer to page 6 for important disclosures and analyst certification, or on our website

2 Analysis Fig 1 Vodafone subscriber numbers stabilising Fig 2 Vodafone subscriber adds by category Postpaid trends solid while MVNO drags k 8,000 7,000 6,000 7,576 7,201 7,022 6,844 6,579 6,028 5,348 5,211 5,302 5,255 k , ,000 3, ,000 1, H14 1H H10 1H11 2H11 1H12 2H12 1H13 2H13 1H14 2H14 1H15 Pre-paid Post-paid MVNO Total Source: Company data, Macquarie Research, July 2015 Source: Company data, Macquarie Research, July 2015 Fig 3 Vodafone s service revenue trends improving, as expected Fig 4 levels But Vodafone revenues still well below historic % ch vs pcp 5% -1.1% 0% -3.0% -5% -9.6% -8.9% -9.0% -10% -11.0% -14.3% -15.8% -15% -17.8% December year end -20% 1H11 2H11 1H12 2H12 1H13 2H13 1H14 2H14 1H15 Service revenue Total revenue $m 2, , , ,000 2,261 2,077 2,011 1,750 1,653 1,499 1,494 1,366 1,359 1, H10 1H11 2H11 1H12 2H12 1H13 2H13 1H14 2H14 1H15 Service revenue Handset revenue Source: Company data, Macquarie Research, July 2015 Source: Company data, Macquarie Research, July July

3 Fig 5 Opex growing again as Vodafone begins to reinvest in the business Fig 6 Pressuring Vodafone s EBITDA in the near term % ch vs pcp 15% 10% 4.2% 5% 0.9% 0% -5% -7.4% -10% -15% -3.9% -6.2% 6.0% 8.7% $m December year end % -25% -30% -26.0% -28.3% % 1H11 2H11 1H12 2H12 1H13 2H13 1H14 2H14 1H15-1H10 2H10 1H11 2H11 1H12 2H12 1H13 2H13 1H14 2H14 1H15 Source: Macquarie Research estimates, July 2015 Source: Macquarie Research estimates, July July

4 (TLS AU) - Closing Price $6.43 Interim results 1H14a 2H14a 1H15a 2H15e Profit & Loss FY14a FY15e FY16e FY17e Sales Revenue $m Sales Revenue $m Total Operating Revenue $m Total Operating Revenue $m EBITDA $m EBITDA $m Depreciation $m Depreciation $m Amortisation $m Amortisation $m Consolidated EBIT $m Consolidated EBIT $m Non-recurring items $m (210) Non-recurring items $m Share of Associates $m 0 24 (10) 24 Share of Associates $m Reported EBIT $m Reported EBIT $m Net Interest expense $m Net interest expense $m Pre-Tax Profit $m Pre-Tax Profit $m Tax consolidated $m Tax consolidated $m Tax on NRIs $m (8) Tax on NRIs $m Total tax expense $m Total tax expense $m Net profit after tax $m Net profit after tax $m Outside equity interests $m Outside equity interests $m Reported Earnings $m Reported Earnings $m Adjusted Earnings 1 $m Adjusted Earnings 1 $m Gross Cashflow 2 $m Gross Cashflow 2 $m Adjusted for NRIs and Goodw ill 2 Gross Cashflow is Profit after Tax plus Amortisation Depreciation and Amortisation Profit and Loss ratios 1H14a 2H14a 1H15a 2H15e Profit and Loss ratios FY14a FY15e FY16e FY17e PER (adj Earnings) x PER (adj Earnings) x EPS (Reported) c EPS (Reported) c EPS (Adjusted) c EPS (Adjusted) c DPS c DPS (Adj Earnings) c Dividend Yield % 2.3% 2.3% 2.3% 2.4% Dividend Yield % 4.6% 4.7% 5.3% 5.9% Revenue Growth % 3.6% 3.4% 0.7% 0.9% Revenue Growth % 3.5% 0.8% 5.4% 0.9% Reported EBITDA Growth % Reported EBITDA Growth % 0.0% 0.0% 0.0% 0.0% Reported EBITDA Margin % 41.2% 41.3% 40.6% 41.4% Reported EBITDA Margin % 41.2% 41.0% 40.3% 39.7% Reported EBIT Growth % 7.3% 10.8% 9.9% -13.0% Reported EBIT Growth % 9.2% -3.0% 16.8% 11.1% Reported EBIT Margin % 23.8% 30.6% 25.9% 26.5% Reported EBIT Margin % 27.2% 26.2% 29.0% 31.9% Effective tax rate % 31.9% 24.9% 29.3% 30.6% Effective tax rate % 27.9% 29.9% 29.9% 29.9% Payout ratio % 105.9% 72.6% 88.7% 92.1% Payout ratio % 85.9% 90.4% 85.3% 83.8% EV/EBIT x EV/EBIT x EV/EBITDA x EV/EBITDA x Balance sheet ratios Balance sheet ratios ROE % 26.8% 38.5% 30.7% 30.4% ROE % 32.4% 30.3% 35.1% 37.5% ROA % 18.6% 18.2% 18.4% 17.8% ROA % 18.7% 17.6% 18.5% 18.8% ROFE % 23.8% 27.8% 23.6% 24.2% ROFE % 27.3% 24.1% 25.5% 26.2% Net Debt $m Net Debt $m Net Debt/Equity % 112.9% 77.8% 106.4% 102.4% Net Debt/Equity x 77.8% 102.4% 89.1% 71.4% Net Debt/EBITDA x Net Debt/EBITDA x Net Interest Cover (EBIT) x Net Interest Cover (EBIT) x Net Interest Cover (EBITDA) x Net Interest Cover (EBITDA) x Price/NTA x Price/NTA x NTA per share $ NTA per share $ EFPOWA m EFPOWA m Cashflow Analysis 1H14a 2H14a 1H15a 2H15e Cashflow Analysis FY14a FY15e FY16e FY17e EBITDA $m EBITDA $m Incr. in WC $m (508) 555 (687) Incr. in WC $m 47 (9) (45) (7) - Net interest expense $m (437) (360) (401) (428) - Net interest expense $m (797) (829) (840) (738) - Tax paid $m (731) (1043) (927) (917) - Tax paid $m (1774) (1844) (2116) (2409) + Other op. cashflows $m Other op. cashflows $m ,029 1,904 Total operating cashflows $m Total operating cashflows $m Capex $m (2,069) (1,949) (3,164) (1,590) - Capex $m (4,018) (4,754) (3,909) (3,460) - Acquisitions / (Divestments) $m (168) 168 (489) (860) - Acquisitions / (Divestments) $m 0 (1349) Other inv. Cashflows $m Other inv. Cashflows $m Total investing cashflows $m (2196) 751 (3565) (2450) Total investing cashflows $m (1445) (6015) (3909) (3460) - Dividends paid $m (1742) (1825) (1866) (1834) - Dividends paid $m (3567) (3700) (3973) (4401) + Equity raisings $m (61) 189 (1058) 0 + Equity raisings $m 128 (1058) Debt raisings $m 536 (442) (1211) (454) - Debt raisings $m 94 (1665) (1123) (1820) + Other fin. cashflows $m 51 (189) Other fin. cashflows $m (138) Total Financing cashflow $m (1216) (2267) (3722) (2288) Total Financing cashflow $m (3483) (6010) (5096) (6221) Free Cashflow $m Free Cashflow $m Net Change in cash/debt $m (45) 3,098 (3,931) 0 Net Change in cash/debt $m 3,053 (3,931) 0 0 Valuation Balance Sheet FY14a FY15e FY16e FY17e Cash $m Receivables $m Inventories $m Investments $m Property, plant & equipment $m Intangibles $m Other Assets $m Total Assets $m Payables $m Short Term Debt $m Long Term Debt $m Other Liabilities $m Total Liabilities $m Shareholders Funds $m Minority Interests $m Total Shareholders Equity $m Total Funds employed $m Source: Company data, Macquarie Research, July July

5 Fundamentals Macquarie Quant View The quant model currently holds a strong positive view on Telstra Corporation. The strongest style exposure is Profitability, indicating this stock is efficiently converting its investments to earnings as proxied by ratios such as ROE, ROA etc. The weakest style exposure is Growth, indicating this stock has weak historic and/or forecast growth. Growth metrics focus on both top and bottom line item 8/173 Global rank in Telecommunication Services % of BUY recommendations 23% (3/13) Number of Price Target downgrades 0 Number of Price Target upgrades 1 Attractive Quant Local market rank Global sector rank Displays where the company s ranked based on the fundamental consensus Price Target and Macquarie s Quantitative Alpha model. Two rankings: Local market (Australia & NZ) and Global sector (Telecommunication Services) Macquarie Alpha Model ranking A list of comparable companies and their Macquarie Alpha model score (higher is better). Factors driving the Alpha Model For the comparable firms this chart shows the key underlying styles and their contribution to the current overall Alpha score % -80% -60% -40% -20% 0% 20% 40% 60% 80% 100% Valuations Growth Profitability Earnings Momentum Price Momentum Quality Macquarie Earnings Sentiment Indicator The Macquarie Sentiment Indicator is an enhanced earnings revisions signal that favours analysts who have more timely and higher conviction revisions. Current score shown below. Drivers of Stock Return Breakdown of 1 year total return (local currency) into returns from dividends, changes in forward earnings estimates and the resulting change in earnings multiple % -20% -10% 0% 10% 20% 30% Dividend Return Multiple Return Earnings Outlook 1Yr Total Return What drove this Company in the last 5 years Which factor score has had the greatest correlation with the company s returns over the last 5 years. DPS Revisions 3 Month Turnover(USD) 125 Day Earnings Certainty (NTM) Price to Book FY0 Altman Z-Score Dividend Cover Return on Equity FY0 ROIC FY0-25% -25% -28% -29% Negatives Positives 16% 15% 15% 18% -30% -20% -10% 0% 10% 20% 30% How it looks on the Alpha model A more granular view of the underlying style scores that drive the alpha (higher is better) and the percentile rank relative to the sector and market. Alpha Model Score Valuation Growth Profitability Earnings Momentum Price Momentum Quality Capital & Funding Liquidity Risk Technicals & Trading Normalized Score Percentile relative to sector(/173) Percentile relative to market(/412) Source (all charts): FactSet, Thomson Reuters, and Macquarie Research. For more details on the Macquarie Alpha model or for more customised analysis and screens, please contact the Macquarie Global Quantitative/Custom Products Group (cpg@macquarie.com) 21 July

6 Important disclosures: Recommendation definitions Macquarie - Australia/New Zealand Outperform return >3% in excess of benchmark return Neutral return within 3% of benchmark return Underperform return >3% below benchmark return Benchmark return is determined by long term nominal GDP growth plus 12 month forward market dividend yield Macquarie Asia/Europe Outperform expected return >+10% Neutral expected return from -10% to +10% Underperform expected return <-10% Macquarie First South - South Africa Outperform expected return >+10% Neutral expected return from -10% to +10% Underperform expected return <-10% Macquarie - Canada Outperform return >5% in excess of benchmark return Neutral return within 5% of benchmark return Underperform return >5% below benchmark return Macquarie - USA Outperform (Buy) return >5% in excess of Russell 3000 index return Neutral (Hold) return within 5% of Russell 3000 index return Underperform (Sell) return >5% below Russell 3000 index return Volatility index definition* This is calculated from the volatility of historical price movements. Very high highest risk Stock should be expected to move up or down % in a year investors should be aware this stock is highly speculative. High stock should be expected to move up or down at least 40 60% in a year investors should be aware this stock could be speculative. Medium stock should be expected to move up or down at least 30 40% in a year. Low medium stock should be expected to move up or down at least 25 30% in a year. Low stock should be expected to move up or down at least 15 25% in a year. * Applicable to Asia/Australian/NZ/Canada stocks only Recommendations 12 months Note: Quant recommendations may differ from Fundamental Analyst recommendations Financial definitions All "Adjusted" data items have had the following adjustments made: Added back: goodwill amortisation, provision for catastrophe reserves, IFRS derivatives & hedging, IFRS impairments & IFRS interest expense Excluded: non recurring items, asset revals, property revals, appraisal value uplift, preference dividends & minority interests EPS = adjusted net profit / efpowa* ROA = adjusted ebit / average total assets ROA Banks/Insurance = adjusted net profit /average total assets ROE = adjusted net profit / average shareholders funds Gross cashflow = adjusted net profit + depreciation *equivalent fully paid ordinary weighted average number of shares All Reported numbers for Australian/NZ listed stocks are modelled under IFRS (International Financial Reporting Standards). Recommendation proportions For quarter ending 30 June 2015 AU/NZ Asia RSA USA CA EUR Outperform 46.23% 58.36% 47.27% 44.20% 60.65% 43.01% (for US coverage by MCUSA, 9.68% of stocks followed are investment banking clients) Neutral 37.67% 25.65% 29.09% 49.29% 34.19% 40.93% (for US coverage by MCUSA, 5.53% of stocks followed are investment banking clients) Underperform 16.10% 15.99% 23.64% 6.52% 5.16% 16.06% (for US coverage by MCUSA, 1.38% of stocks followed are investment banking clients) TLS AU vs ASX 100, & rec history (all figures in AUD currency unless noted) Note: Recommendation timeline if not a continuous line, then there was no Macquarie coverage at the time or there was an embargo period. Source: FactSet, Macquarie Research, July month target price methodology TLS AU: A$6.30 based on a DCF methodology Company-specific disclosures: TLS AU: MACQUARIE CAPITAL (AUSTRALIA) LIMITED or one of its affiliates has provided Ltd with investment advisory services in the past 12 months, for which it received compensation. Macquarie and its affiliates collectively and beneficially own or control 1% or more of any class of Limited's equity securities. Important disclosure information regarding the subject companies covered in this report is available at Date Stock Code (BBG code) Recommendation Target Price 13-Feb-2015 TLS AU Neutral A$ Feb-2015 TLS AU Neutral A$ Dec-2014 TLS AU Neutral A$ Aug-2014 TLS AU Neutral A$ Feb-2014 TLS AU Neutral A$ Aug-2013 TLS AU Neutral A$ Jul-2013 TLS AU Neutral A$ Jan-2013 TLS AU Neutral A$ Aug-2012 TLS AU Neutral A$3.70 Target price risk disclosures: TLS AU: Any inability to compete successfully in their markets may harm the business. This could be a result of many factors which may include geographic mix and introduction of improved products or service offerings by competitors. The results of operations may be materially affected by global economic conditions generally, including conditions in financial markets. The company is exposed to market risks, such as changes in interest rates, foreign exchange rates and input prices. From time to time, the company will enter into transactions, including transactions in derivative instruments, to manage certain of these exposures. Analyst certification: The views expressed in this research reflect the personal views of the analyst(s) about the subject securities or issuers and no part of the compensation of the analyst(s) was, is, or will be directly or indirectly related to the inclusion of specific recommendations or views in this research. The analyst principally responsible for the preparation of this research receives compensation based on overall revenues of Macquarie Group Ltd (ABN , AFSL No ) ( MGL ) and its related entities (the Macquarie Group ) and has taken reasonable care to achieve and maintain independence and objectivity in making any recommendations. 21 July

7 General disclosure: This research has been issued by Macquarie Securities (Australia) Limited (ABN , AFSL No ) a Participant of the Australian Securities Exchange (ASX) and Chi-X Australia Pty Limited. This research is distributed in Australia by Macquarie Equities Limited (ABN , AFSL No ) ("MEL"), a Participant of the ASX, and in New Zealand by Macquarie Equities New Zealand Limited ( MENZ ) an NZX Firm. Macquarie Private Wealth s services in New Zealand are provided by MENZ. Macquarie Bank Limited (ABN , AFSL No ) ( MBL ) is a company incorporated in Australia and authorised under the Banking Act 1959 (Australia) to conduct banking business in Australia. None of MBL, MGL or MENZ is registered as a bank in New Zealand by the Reserve Bank of New Zealand under the Reserve Bank of New Zealand Act Any MGL subsidiary noted in this research, apart from MBL, is not an authorised deposit-taking institution for the purposes of the Banking Act 1959 (Australia) and that subsidiary s obligations do not represent deposits or other liabilities of MBL. MBL does not guarantee or otherwise provide assurance in respect of the obligations of that subsidiary, unless noted otherwise. This research is general advice and does not take account of your objectives, financial situation or needs. Before acting on this general advice, you should consider the appropriateness of the advice having regard to your situation. We recommend you obtain financial, legal and taxation advice before making any financial investment decision. This research has been prepared for the use of the clients of the Macquarie Group and must not be copied, either in whole or in part, or distributed to any other person. If you are not the intended recipient, you must not use or disclose this research in any way. If you received it in error, please tell us immediately by return and delete the document. We do not guarantee the integrity of any s or attached files and are not responsible for any changes made to them by any other person. Nothing in this research shall be construed as a solicitation to buy or sell any security or product, or to engage in or refrain from engaging in any transaction. This research is based on information obtained from sources believed to be reliable, but the Macquarie Group does not make any representation or warranty that it is accurate, complete or up to date. We accept no obligation to correct or update the information or opinions in it. Opinions expressed are subject to change without notice. The Macquarie Group accepts no liability whatsoever for any direct, indirect, consequential or other loss arising from any use of this research and/or further communication in relation to this research. The Macquarie Group produces a variety of research products, recommendations contained in one type of research product may differ from recommendations contained in other types of research. The Macquarie Group has established and implemented a conflicts policy at group level, which may be revised and updated from time to time, pursuant to regulatory requirements; which sets out how we must seek to identify and manage all material conflicts of interest. The Macquarie Group, its officers and employees may have conflicting roles in the financial products referred to in this research and, as such, may effect transactions which are not consistent with the recommendations (if any) in this research. The Macquarie Group may receive fees, brokerage or commissions for acting in those capacities and the reader should assume that this is the case. The Macquarie Group s employees or officers may provide oral or written opinions to its clients which are contrary to the opinions expressed in this research. Important disclosure information regarding the subject companies covered in this report is available at 21 July

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