MELBOURNE (S&P Global Ratings) May 28, 2018--S&P Global Ratings today said it has lowered its long-term issuer and issue ratings on Australian telecommunications company Telstra Corp. Ltd. to 'A-' from 'A'. At the same time, we lowered the short-term rating to 'A-2' from 'A-1'. The outlook is stable.
The downgrade reflects our view that Telstra's strong incumbent position within the Australian telecommunications industry has diminished somewhat. Competition has intensified across Telstra's core businesses and the company has had to accept lower margins as a means of protecting its dominant market share.
The Australian mobile market has become highly competitive. In our opinion, Telstra's vulnerability to an erosion of its price premium and dominant market share has increased over the past few years despite elevated network investment. Competing mobile network operators have also made large investments in their networks and product offerings. We expect competition to further intensify with the likely entry of TPG Telecom as Australia's fourth mobile network operator.
In addition, Telstra is progressively transferring its high-margin fixed-line access network to the government-owned national broadband network (NBN) in exchange for a series of compensation payments. The majority of this compensation is likely to be returned to shareholders. The establishment of the NBN will structurally separate Telstra's fixed-line services, leaving it to compete on equal terms against a fragmented market of retail service providers.
We believe the earnings impact of migrating to the NBN is likely to be at least A$3 billion (previous guidance A$2 billion-A$3 billion). This has been exacerbated by retailers aggressively pursuing market share and onerous NBN wholesale charges. Telstra intends to fill this gap through a combination of cost savings and strategic investments.
In our opinion, there are execution risks associated with the company's strategic initiatives, including its vision of becoming a world-class technology company that empowers people to connect. We view new earning streams generated in the group's Network and Application Services division as being of generally weaker quality compared with the lost fixed-line earnings.
We continue to view Telstra's ability to generate a pricing premium from its dominant mobile network infrastructure as a key differentiator from its peers, warranting a one-notch rating uplift from its lowered anchor score.
Our base-case operating scenario assumes that a combination of cost savings and strategic investments will fill a A$3 billion earnings gap. Our base case also assumes that Telstra will size shareholder returns in a manner that is consistent with its stated balance sheet settings.
The stable outlook on Telstra reflects the company's dominant network infrastructure and our expectation that the group will adhere to its stated financial policies. The rating can accommodate marginally higher leverage in the near term for restructuring initiatives that have an enduring benefit to Telstra's earnings profile.
We could lower the rating if:
- Telstra's fully adjusted debt-to-EBITDA ratio (including a pro rata consolidation of Foxtel and excluding any one-off net receipts associated with the NBN compensation in our EBITDA calculations) remains at more than about 2x after fiscal 2019; or
- The competitive environment in mobile services intensifies to the extent that Telstra's ability to generate a meaningful premium pricing has substantially eroded.
We see the potential for an upgrade as unlikely in the short term given the group's structural industry challenges. We could consider an upgrade if Telstra adopts a more conservative financial policy and is able to maintain consistent cash flows from its core operations.