“Eh, eh, eh, eh, eh, eh, eh, eh, eh, eh,” sings Lady Gaga in Telephone, which is a song all about how she ignores telephones. Investors have also been ignoring telephones: TalkTalk shares are down 36 per cent in the year to date and those of BT are off more than 43 per cent.

As of this morning, however, shareholders of both companies have reasons not to say “Eh, eh, eh, eh, eh, eh, eh, eh, eh, eh.” For TalkTalk there’s a report on Sky News that the company rejected a takeover offer more than a year ago from key shareholder Toscafund. For BT there’s an unusual level of interest in advance of a Q1 update due Friday.

Barclays turns positive-ish ahead of BT’s update:

Openreach has indicated plans to build FTTP to 20m homes over the next 5-10 years. The challenges are to firstly secure favourable regulation (largely done), then build it (already well underway), and now to secure scale wholesale deals with the major UK service providers. We believe this could happen shortly. It would, in our view, likely be taken positively, and with Telcos generally performing well this quarter we see positive catalysts ahead, and we upgrade our rating to EW (was UW) and our PT to GBp130 (was GBp115).

What does an Openreach volume commitment Fibre deal look like? We have seen an extended period of price discovery for Openreach’s FTTH offering. Given changing service provider attitudes, we could imagine Openreach announcing terms of its FTTP pricing (similar to July 2018) at some point shortly. Key questions will be the scope of any offer (nationwide vs regional), copper switch-off commitments and speed/take-up requirements vs volume discounts. We would expect Ofcom to analyse any deal in detail, given the potential impact any putative deal could have on future infrastructure competition. We would expect service providers to want to preserve regional optionality (as in July 2018), with Openreach seeking to secure volume commitments wherever possible. We would anticipate a deal to appear broadly supportive for BT, especially in the context of the implication for Openreach’s value. . . . 

1Q – Beating EBITDA expectations a consistent theme –Could BT be “reassuring?” EU Telcos have beaten EBITDA by c3% this quarter, as lower costs have more than offset revenue weakness. On TV, we note Telia having changed how/when they account/accrue for Sports content costs (pushed to later quarters). We also note TalkTalk broadband churn fell c30%in the quarter, even if Revenues/ARPU were light. For Q1, we model BT Revs/EBITDA -10%/-12% (company cons: -8%/-11%).Valuation is relatively undemanding–130p PT.We estimate BT trades on 5.8x EV/EBITDA, well below EU incumbents on 6.9x (on IFRS16 basis). On unlevered FCF however, the stock trades on 5.5% vs peers on 5.8%. Adjustingfor FTTH investments, (remove FTTH capex, add NPV of future capex), it is still 6.2% vs peers on 6.1%

And JP Morgan Cazenove’s rather more positive on BT in a sector thing:

The UK Telco industry has suffered a painful multi-year downgrade cycle. Key contributing factors, amongst many others, have included competition, regulation, rising capex needs, and retail price deflation. Notably over the last five years we have seen consensus EPS forecasts for BT rebased 50%, and those of TalkTalk fall an even greater 70%. Whilst many of the key risks have now played out, we feel visibility is insufficient for us to call the bottom as yet, with a high degree of conviction. Critical for the outlook is: (1) regulatory clarity on fibre – Q1 2021, (2); the regulatory approval process for the VMED/O2UK – likely mid-2021; and (3) the UK economic recovery post COVID-19 given the implications this has for the Enterprise market revenue outlook. Should the above play out favourably, we see scope for BT to enjoy a substantial rebound through 2021 and beyond.

 The UK downgrade cycle. The UK Telco industry is in the midst of a painfully long downgrade cycle. Since the beginning of 2016, we have seen consensus EPS forecasts for BT fall 50%, and those of TalkTalk fall 70%. As a result, both companies have seen their shares de-rate by ~70%. The pace of downgrades has only intensified YTD, given the fall-out related to COVID-19. As a case in point, we note BT consensus revenues, EBITDA, and FCF have fallen 4%, 6% and 25%, respectively, YTD.

 The BT overhangs. We have long argued BT faces a long laundry list of overhangs. Positively, this note highlights a number have played out, and been resolved, over recent months (dividend cut, Huawei resolution, retail price regulation, fibre capex hike). That said, we note four outstanding ‘unknowns’, namely: (1) Fibre regulation update (Q1’2021); (2) Pension triennial review (mid’2021); (3) UK consolidation (mid-2021); and (4) Greater visibility on the private equity FttH over-build risk.

 BT (TP 160p) – Returning to growth is key. BT reports Q1 results on 31st July. We expect COVID-19 related pressures to weigh on trends and model revenues -7.2% y/y (Q4 -3.8%) and EBITDA -11.0% y/y (Q4 -0.9%). But with now Mar-21E consensus meaningfully rebased, it provides an easy base of comparison, offering scope for a long-awaited return to growth. Moreover, if the remaining overhangs play out in a benign manner, we think BT should be able to sustain modest revenues and EBITDA growth midterm, supporting a material valuation re-rating.

TalkTalk (TP 89p) – Consensus rebased, H2 trends should improve. Talk reported a weaker than expected Q1 last week, with revenues -7.5% (Q4 -4.1%), triggering further downgrades. Mar-21E consensus revenues have rebased 6% YTD. Management’s call for a rebound in trends through the remainder of the year is supported by: (1) Significant ARPU improvements seen through June and July, and (2) The guided to £15m EBITDA impact from COVID-19 now being seen as conservative.

Numis, meanwhile, isn’t really looking forward to the results:

We think BT’s Update will be a ‘non-event’ for its share price unless management provides explicit EBITDA and FCF guidance for FY21, and/or, much more preferably, explicit mid-term EBITDA guidance. Unfortunately, based mainly on our experience of BT, we doubt either of these bullish scenarios are probable. Our rating and DCF based Target Price remain an unenthusiastic Buy and 145p/share, respectively.

The backdrop to all this, of course, is the FT story back in May about BT entering talks to sell a stake in Openreach (which drew an unorthodox and complicated denial) and a Telegraph story about a month later about Saudi Arabia’s Public Investment Fund building a stake in BT. These may be unconnected threads that come to nothing but, given the dearth of UK deals at the moment, it would be a lazy and imaginative M&A banker who didn’t have a BT breakup/take private pitchbook drawn up just in case.

As for the TalkTalk take private, Tosca’s reported 135p a share offer was at approximately a 23 per cent premium to the share price last June. The stumbling point was likely to be the backing of founders Charles Dunstone and David Ross, who have a combined holding of 41.1 per cent. It’s worth noting also that Tosca seems to be deep under water, having raised its TalkTalk holding from 19 per cent to 28.6 per cent at around the time of the reported offer. Here’s UBS:

An offer of 135p would imply £1.56bn of equity value and an EV of around £2.3bn with implied calendarised multiples of 8.8x EV/EBITDA, 15.4x EV/OpFCF and a 6.3% EFCF yield and 1.9% dividend yield for 2021E. . . . 

... Of course we acknowledge that does not mean another offer [from Tosca] could be forthcoming. We think there are things that may be different today compared with 12 months ago: [1] The competitive environment has deteriorated around the introduction of End of Contract Notification in February 2020, although there are signs this has improved in recent weeks. However, we remain wary of rising competition in the value segment of the market with VOD pricing lower than TalkTalk and scope for VMED to launch a challenger brand; [2] COVID-19 led to worse-than-expected revenue trends in Q1-21, but there are signs that TalkTalk may be past the worst; [3] Net debt has been higher than expected as a result of adverse working capital movements and it is not clear whether this will reverse.

At a price of 75p, TalkTalk trades on 6.0x EV/EBITDA, 10.6x EV/OpFCF and offers an 11.3% EFCF yield and 3.3% dividend yield on a calendarised basis for 2021E.

Before we leave telecoms, Exane BNP Paribas has a big push of Deutsche Telekom (target €17.5) in combo with an initiation of T-Mobile US (target $130). Its research “offers two unique insights for both European and US investors. First, our ‘STAMP’ survey, which brings five years of proprietary data on NPS, switching preferences, customer overlap and more for 4.5k US respondents with zip-code level detail. Second, the lessons learnt from regulator-backed new entrants and fixed/mobile convergence in Europe – and why we think that neither poses an immediate risk to TMUS.”

New T-Mobile is in an enviable position: post Sprint merger it not only has the best loved brand but also more spectrum than peers, and a bucket-load of synergies to re-invest. The TMUS growth story has a long way to run. . . . 

5G rollout and telco/media convergence open the door to a wide range of market structures in the US longer term. But over the next three years we expect commercial momentum and synergy delivery to be most important for the TMUS investment case, and our analysis suggests upside in both regards. A standout brand position and increased network investments support not just Sprint migration, but also mean that TMUS can win more share from dissatisfied Verizon/ AT&T subs, particularly in underpenetrated rural areas. With +2%/+10% revenue/EBITDA CAGR over the next three years, we forecast TMUS ‘real’ FCF increasing to +$9 bn by 2023 (vs. -$8 bn in 2020).

DT faces the same challenges as most incumbent telcos: declining legacy revenues, regulation and capex risk. But Germany is still one of the most attractive telco markets in Europe, and DT’s costcutting efforts can help to amplify the benefits of rising prices in a stable market structure. Fibre capex does remain an overhang, but DT could sell towers and/or ancillary businesses to fund investments, if needed. Most importantly, the growth delivered by the US operations means that on a consolidated basis DT offers the highest growth amongst EU incumbent telcos (+2%/+6% revenue/EBITDA CAGR), and proportionate FCFE should rise to EUR 6.4 bn by 2023 (implying a c.9% yield). Investors who can buy TMUS directly should – but DT group is highly attractive as well.

UK housebuilders such as Barratt are up on the rising certainty of another extension to the Help to Buy newbuild mortgage subsidy, which is due to expire in December. A later deadline will be “to prevent buyers losing out owing to Covid-19 delays,” the FT reports.

You might have thought that house prices had held steady post lockdown and newbuild demand was surprising on the upside. You might also have thought that extending a mortgage subsidy can only give more insulation to the builders’ cartel, which finds itself in an ever stronger position to keep generating super-normal margins on artificially constrained supply at a time when secondary mortgage availability has dried up. You might have thought that because it’s exactly what is happening. Here’s UBS:

Base case scenario: With activity gradually returning to more normal levels post the lockdown, we expect volumes to drop by -32% in 2020E and to grow by +25% in 2021E and +6% in 2022E, bringing 2022E sector volumes to 90% of 2019 level. We expect volumes to recover to 2019 level by 2025E taking into account a headwind on growth from HTB phase-out currently scheduled for 2021-23. We expect ASP to remain broadly flat in 2020-22E with broadly flat house prices (slightly negative including mix effects). House price direction is the main and most uncertain driver for the sector in the current environment. We expect operating margins to see a decline of -4ppts y/y in 2020E to ~16% and then gradually improve to 18% by 2022E on improving top-line and fractionalisation of fixed costs. Beyond this, we expect margins to improve to 19%, still below peak levels, to account for the phase-out of HTB. Consequently, adjusted ROCE should see a bottom of ~11.5% in 2020E and gradually pick up to a normalised ~19% long-term average level. Our price targets suggest ~22% average upside TSR potential in the sector.

Downside scenario: In the event where unemployment pressure post lockdowns takes its toll on consumer confidence and mortgage liquidity tightens, the housing market could take much longer to recover to 2019 level. Under a downside scenario, we factor in 2022E volumes at just ~75% of 2019 level and a further decline from the ending of HTB of ~10% in CY23-25E with resulting 2025E volumes 35% below 2019. We also assume ~3% house price deflation over CY20-22E, which results in ~10ppt of operating margin compression to average ~11%. Under this scenario, we estimate ROCE declines to ~9% by 2022 and ~9.5% in the longer term. We see an average ~65% TSR downside in this scenario.

Upside scenario: In a more optimistic scenario, volumes would reach 2019 levels by 2022E and be +15% above 2019 in 2025E. This would require improved levels of consumer confidence, continuation of favourable mortgage market conditions and further government support (e.g. a HTB extension). Under this scenario, we also think house prices would increase by 3% by 2022E on 2019 levels. Operating margins would increase significantly vs our base case on the back of better pricing, fixed cost fractionalisation and stable building & labour cost environment. We see operating margins at ~23% by 2022E (+2pp vs 2019) and 25% in the longer term under this scenario, implying adjusted ROCE of ~25%. We see ~100% TSR upside potential under this scenario.

Bank of America is pushing Berkeley, the sector’s leading land hoarder and builder of high-end luxury apartments in places like Enfield, Haringey and West Ham. “Berkeley's focus on quality over volumes sustains higher margins, supporting free cash generation and shareholder returns,” says BoA. “Short-term tailwinds include: UK peers reducing London exposure, Project Speed easing planning & UK visas for HK residents. Valuation premium justified and trades at c14% discount to historical P/B. Reiterate Buy, PO raised to GBp5,300.”

Elsewhere in sellside, Centrica (now up 52 per cent since this column in your red hot penny stock-tipping Weekend FT) goes onto Jefferies’ “buy” list:

The disposal of CNA’s US business for £2.85bn (+22p vs JEFe) is in our view transformational and shows management taking back control after an uncontrollable period. Additionally, 1H20 COVID hit of £60m was lower than we expected resulting in a 25% cut to JEFe FY20 COVID impact. With this, and a recovery in commodity prices, we increase FY20/21 EPS +25% despite deal dilution. CNA is +20% since deal announcement but remains at a 45% discount to the sector.

Transformative US disposal gives line of sight to c.1x ND/EBITDA. On Friday, Centrica announced the sale of its North American business to NRG for net cash proceeds of £2.7bn (gross valuation £2.85bn). This has dramatically improved the outlook for Centrica’s balance sheet. Assuming a £1bn contribution towards the triennial pension deficit, we see FY21 net debt of £1.6bn (ND/EBITDA of 1.0x). Centrica also remains committed to the disposal of Spirit Energy (E&P), which we believe could achieve a £0.6bn valuation (at $4/boe). This would bring net debt to just £1bn, which would imply a ND/EBITDA of <1x for the core business.

We lower our forecasted FY20 COVID-19 hit by 25% to £200m following £60m in 1H20. In 1H, Centrica saw a gross impact from COVID-19 of £220m (£100m due to lower demand; £60m reduced services activity; £60m bad debts). This was offset by mitigating factors (mgmt. bonus cuts; discretionary cost savings; government support schemes) of £160m to give a net impact of £60m. For 2H20, we are cautiously assuming a near doubling to £100m in bad debts, £40m impact relating to lower demand and no meaningful impact from mitigation actions. With this, we now see a FY20 net impact of £200m from COVID-19 (£260m previously). With a newly strengthened balance sheet, we now see Centrica having the capacity to weather a tougher 2H backdrop.

We increase our FY20/21 EPS forecasts by 25% on average. We are increasing our FY20e EPS to 4.4p (from 3.1p) and FY21e EPS to 4.7p (from 4.5p). The former is 25% above current Bloomberg 28-day consensus whilst the latter is inline despite the disposal of CNA’s US business (2.5p EPS hit). The movement in FY20 is due largely to lower COVID-19 hit (+0.8p) and the 1H20 performance in EM&T (+1.3p), whilst the upgrade in FY21 is due to the recovery in commodity/power prices (+0.9p) and accelerated cost savings (+1p). With this, we increase our FY21 DPS to 3.0p (from 2.0p).

Despite moving +20% since Friday, Centrica remains at a record discount. YTD, Centrica has underperformed at -46% vs the sector (SX6P) at +0%. This now means that Centrica is trading at a 45% discount to the sector (SX6P) in terms of +2yr fwd P/E vs the 5yr avg of a 15% discount. One factor impacting underperformance, is a reduced E&P valuation, and we now carry £0.6bn vs a £1.2bn valuation in Dec ‘19. The -£0.6bn change in our E&P valuation is equivalent to c.11p. Excluding this, Centrica’s YTD performance has been -38%, still implying a significant underperformance vs the sector.

We increase our PT +100% to 60p; Upgrade to Buy. The benefits of the US deal are by far the largest factor adding +22p, whilst there are also moving parts around the current cost savings plan.

And Canaccord’s pushing Cairn Energy:

Cairn's anticipated exit from Senegal following the $300m+ cash sale to Lukoil is, in our view, a very positive step for the company. It dramatically strengthens the balance sheet not just in terms of the near-term cash injection, but also through the elimination of anticipated c.$1.5bn net capex ahead of projected first oil from the Sangomar field in 2023. That would have seen Cairn's balance sheet move from net cash to substantial net debt over the next few years whilst retaining significant project risk.

The company's promise to return cash to shareholders following transaction completion - a minimum $250m special dividend is planned - is also very welcome. Cairn's ability to make such distributions clearly differentiates it from its more indebted peers. In the near term, there is still the potential for a successful outcome to the Indian arbitration case. Beyond that, the company indicates, sensibly in our view, that it will seek to use its balance sheet muscle to acquire additional production assets at a low(ish) point in the cycle. The UK North Sea would be logical given the location of the Catcher and Kraken oilfields, but geographical and hydrocarbon diversification requirement may play a role.

We raise our rating to BUY and our target price to 165p.

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