In this article, we’re looking at Deutsche Telekom (OTCQX:DTEGY). This is an interesting one, given the German and European exposure. I've been planning to do this one for quite a while, to be honest, but things kept coming in the way.
So, let's get into it!
So, in terms of subscriber numbers, Deutsche Telekom is larger than AT&T (T). Far larger. It's larger than Verizon (VZ), It's larger than any telecommunications holding in my portfolio by this metric.
Deutsche Telekom has more than a quarter billion mobile, 27.5 million fixed network, and over 22 million broadband customers. The company's operations that previously were somewhat split into T-Home, T-Mobile, and T-systems have been merged into one.
The company's primary foothold in terms of operations is as the name suggests, Germany. However, Deutsche Telekom also has a firm foothold in Eastern and Southern Europe - and across the pond in the US, the company's subsidiary T-Mobile US is one of the largest telcos in the states with excellent historical and projected growth rates. The company's merger with Sprint is set to catapult revenues to another level entirely, and will in terms of annual revenues come in behind AT&T and Verizon, its main competitors.
The number of US customers alone from this merger comes to 110 million, which is just behind Verizon's 120 million. Aside from customer merging, the M&A has allowed consolidation of 5G rollout and spend.
Deutsche Telekom Germany owns 47% of T-Mobile US, and it's therefore fully consolidated in the company's results. It also received call options to the tune of another 8% of so, which means that DT will likely end up with more than 50% control of the company.
Deutsche Telekom has four operating segments, which are in part region-based and in part customer/product based:
Aside from this, there are also segments for Group Headquarters/Shared Services and developments.
You (likely) know how telcos work. They're asset/infrastructure-heavy companies with usually very high moats due to the massive spending on capex to compete with them. This dynamic creates a typical yield-friendly company due to the recurring income security from its subscribers, balancing with its capex ambitions.
Some companies in the sector "fancy" things up by including things like content creation, television, security services, or in the case of Telus (TU), something like health insurance.
Deutsche Telekom is no different in this respect. The company has massive amounts of recurring net income with security due to its size and customer base. Around 50% of income comes from the US market, the rest from the EU. A pretty much "perfect" split in terms of a global telco.
The credit markets acknowledge DTE's high quality, giving it a BBB+ credit rating. This is despite DTE being above its debt target corridor, and part of its target for 2024 is deleveraging.
Group targets are for single-digit conservative revenue, EBITDA, and FCF increases, while maintaining a RoCE of more than 6.5%. On this, they are a little different than any other telco.
Growth over time has been impressive, more so over on the US side, where the company is capturing market share both through organic and inorganic means.
Company capex spend is high - and expected to increase to €18 billion for full 2021, excluding spectrum. At the same time, the company is reaping the rewards in the form of growing FCF, which has increased by 10% CAGR since 2017. Deutsche Telekom has leading positions on both sides of the Atlantic.
The company is the market leader in Germany and huge parts of eastern Europe and considers itself "attacking" the market of the US, as well as The Netherlands.
The company has already done what most other telcos are in the midst of - cleaning house. DTE has divested its fixed-line assets as well as underperforming, small segments or subsidiaries that were considered non-core, among them Telekom ALB. DTE also has some of the best M&A disciplines I've seen in the sector.
They have consistently refused:
DT has consistently avoided what made other telcos "bad" or risky due to the search for growth in my view, and has, as a result, outperformed most relevant European peers. They are ahead of the game.
On the fiscal side, things are looking extremely good. DT Germany is maintaining a 40% EBITDA margin, and over time this actually looks as though it's sustainable, not only across Germany but across the entire company, leading to some truly impressive RoE numbers.
Margin improvements here are very unlikely (more on that in risks), and the margins for DT in Germany are typical for a major legacy player in its own home country. I would be worried if this wasn't the case for DT. It's the same with Orange (ORAN) in France, as I've reported in previous articles.
Another thing that's very important to look at when considering telco finances is their capex spend. I've written about this in the Orange article/s. We consider CapEx in relation to sales revenue, and a typical 13%-15% ratio before 5G-fiber has been pushed to around 18%-20% as a result of fiber rollout and 5G. Fiber is more expensive to push than 5G, so until the companies are finished with this, including DT, these ratios are likely to remain high.
That's also why European legacy players like DTE/ORAN have seen capex price tags of 18%-21% in terms of sales due to heavy fiber rollout. Once fiber is completed - not even 5G, just fiber - that's likely to drop back down to 14%-16%, freeing up more capital for dividends and other things.
The cost of deploying 5G in all of Germany was around €6.7 billion (Source). The same cost for super-fast fiber is over €25 billion.
What's important to recall here is to keep an eye on those capex/sales ratios and see how quickly telcos like DT can get them back down. For now, DT's CapEx is expected to rise to around €29.5B for 2021, but this is a very high point of nearly 27% of sales, expected to go down to below €20 billion in 2022. Current estimates, as well as what I model for, call for a 16-19% CapEx/sales for the foreseeable future, ending up with around €12-€15 billion in annual adjusted Free cash flow.
Going by current expectations, DT is expected to generate an annual EPS of around €1.35, which will significantly rise into 2022 and 2023.
Telcos are what I consider to be utilities of the future. They have rapidly taken the role of a core necessity for most western people. The only issue I see is pricing pressure. Despite their size, the companies in the segment have only limited means of raising prices further. No, more expensive handsets aren't raising prices - I'm talking prices for services. While each generation of mobile equipment prevents prices from falling, there hasn't been much overall increase in average price for service (at least not in Europe) for several years. Instead of telcos gaining the upper hand, the profit has instead gone to device manufacturers such as Apple (AAPL) or Samsung (OTCPK:SSNNF).
The main legacy/EU risk for DTE comes in the form of competition. In both Germany and its Eastern Euro regions, DTE competes with Vodafone (VOD). The peer acquired several telco operations in Germany-adjacent markets in 2019, as well as buying cable operators. In terms of competition, VOD is easily the most serious competitor that DT needs to keep an eye on.
On the fixed side, VOD is bringing gigabit connections to Germany comes to an almost-similar rate to DTE - though DT is still leading the spear tip at 30.5 million. There's no geographical overlap between these two operations because the cable that Vodafone has and the competition were originally two separate networks for different customers.
That means that the nation will have two major telcos vying for that first spot - DTE and VOD. While DTE leads the charge in fixed broadband with a 44% market slice, VOD's network will lead TV at around 33% of distribution vs. only 10% in VOD.
In terms of international competition over on the US side of things, this is easier to understand. The combined TMUS-Sprint operations will be competing with VZ and T, and the growth since the M&A showcases that this could be an interesting three-front battle. I argue that DTE's diversified geographies and income base without the added complexities of massive media segments should make for an appealing case.
As always, however, in the case of excellent public comps - I say "BUY them when they're undervalued."
And I'm buying more.
Remember, DT US is a fully consolidated part of DT. As of yet, and because of CapEx spending and a few other reasons, DT US/TMUS currently does not contribute to the DT dividend one bit because of the merger with Sprint.
This is despite an expected annual TMUS EBITDA of almost €12 billion (after capex, excluding spectrum).
Once this changes, and once investments are winding down and things normalize, it could allow this company to practically double down the dividend to 7%-8%.
That's 7%-8% for one of the largest telcos on the planet - and far safer than a peer like AT&T.
I will go so far as to say that there is only one company-specific headwind for DT at this time, in the light of superb recent quarterly 3Q21 performance including:
Valuation for the company is exciting. On a peer basis, the company is somewhat cheaper than the peer average of around 12X P/E, including European telcos such as Vodafone, Swisscom (OTCPK:SCMWY), Orange, Telia, and others. DTE is at around 10.8X for the native ticker, with a slightly higher EV/EBITDA ratio, as well as a substantially lower average yield of around 4%.
It would be wrong of me to consider this as clear an undervaluation as some might say we're seeing in AT&T or Verizon. However, I do believe that the opportunity here could be larger.
For US investors, the relevant ADR is the DTEGY. DTEGY is a 1:1 ADR. Looking at current FactSet forecasts does confirm the current thesis I'm presenting to you here - at least in part.
No, the company isn't as cheap or undervalued as its peers in terms of P/E - especially not for the ADR. But I will argue firmly that DTE is by far the more qualitative and diversified choice.
Under current forecasts and a P/E of around 15X, you could make just north of 20% annualized RoR until 2023.
Under very conservative estimates and analysis, I'm reaching a minimum long-term valuation of around €22/share. This is despite guiding for less than 2% long-term growth and a WACC of 5.4% based on the current debt/equity cost.
So, a few things.
Another thing is that this is not a T-Mobile US (TMUS) analysis. Do not use this article or research/opinions expressed as a basis for investing in TMUS.
TMUS might be a consolidated part of DTE, but I haven't been looking specifically at TMUS in this article. The stocks touched herein are DTE for Germany and DTEGY for US ADRs.
I believe that Deutsche Telekom represents a significant investment opportunity with appealing upside.
The company is qualitative and has excellent growth as well as momentum in the current market. What you're investing in is a solid yield, with the very real potential for doubling in yield within 3-5 years. I wouldn't be surprised when that happens to see annualized RoR of over 25-30%.
That's why I'm investing in DTE - the native German ticker.
This is a reduced version from iREIT on Alpha. The full article includes specific dividend discussions (including why German shareholders might not have to pay withholding taxes), GAAP/IFRS-16 considered difference for operating and financial leases and the impact they have on results, as well as a significantly more expansive valuation/risk discussion as well as individual targets, upsides, and goals.
I also explain which and why I prefer in terms of TMUS and DTEGY/DTE. None of these excluded considerations change the nature of the bullish thesis, but they go more into detail, arriving at what I believe to be a clearer picture.
Remember, I'm all about:
1. Buying undervalued - even if that undervaluation is slight, and not mind-numbingly massive - companies at a discount, allowing them to normalize over time and harvesting capital gains and dividends in the meantime.
2. If the company goes well beyond normalization and goes into overvaluation, I harvest gains and rotate my position into other undervalued stocks, repeating #1.
3. If the company doesn't go into overvaluation, but hovers within a fair value, or goes back down to undervaluation, I buy more as time allows.
4. I reinvest proceeds from dividends, savings from work, or other cash inflows as specified in #1.
This process has allowed me to triple my net worth in less than 7 years - and that is all I intend to continue doing (even if I don't expect the same rates of return for the next few years).
If you're interested in significantly higher returns, then I'm probably not for you. If you're interested in 10% yields, I'm not for you either.
If you however want to grow your money conservatively, safely, and harvest well-covered dividends while doing so, and your timeframe is 5-30 years, then I might be for you.
Deutsche Telekom is currently in a position where #1 is possible in my process, through #3 and #4.
Thank you for reading.
This article was written by
36 year old DGI investor/senior analyst in private portfolio management for a select number of clients in Sweden. Invests in USA, Canada, Germany, Scandinavia, France, UK, BeNeLux. My aim is to only buy undervalued/fairly valued stocks and to be an authority on value investments as well as related topics.
I am a contributor for iREIT on Alpha as well as Dividend Kings here on Seeking Alpha and work as a Senior Research Analyst for Wide Moat Research LLC.
Disclosure: I/we have a beneficial long position in the shares of DTEGY, ORAN, T, TELNF, TELNY, TLSNF, TLSNY, TLTZF, TLTZY, TU, VOD, VZ either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: While this article may sound like financial advice, please observe that the author is not a CFA or in any way licensed to give financial advice. It may be structured as such, but it is not financial advice. Investors are required and expected to do their own due diligence and research prior to any investment. Short-term trading, options trading/investment, and futures trading are potentially extremely risky investment styles. They generally are not appropriate for someone with limited capital, limited investment experience, or a lack of understanding for the necessary risk tolerance involved. The author's intent is never to give personalized financial advice, and publications are to be viewed as research and company interest pieces.
The author owns the European/Scandinavian tickers (not the ADRs) of all European/Scandinavian companies listed in the articles. The author owns the Canadian tickers of all Canadian stocks written about.