Is NZ telco Chorus a value trap?

Kiwi fixed-line communications company Chorus (ASX: CNU) yesterday announced a sizable full year earnings result for FY13, taking in $917 million (NZ$1.057 billion) in revenue and a net profit after tax (NPAT) of $148 million.

Chorus was split from parent company Telecom (ASX: TEL) in 2011 to set up the country’s ultra-fast broadband (UFB) fibre-optic network and the company achieved a 90% increase in new fibre connections for the year. Chorus also owns the country’s existing copper line connections with over 1.5 million connections accounting for 60 of earnings.

The company is just 18% through its UFB program which will eventually reach up to 149,000 connections. With plenty of growth to come, a good full year result and monopoly position Chorus at first glance looks like a bargain on a current price to earnings (P/E) ratio of 14, especially compared to Telstra’s (ASX: TLS) 16 or M2 Telecommunications’ (ASX: MTU) P/E ratio of 24.

However Chorus comes with a sting in its tail. The company faces ongoing challenges in its regulatory environment and ongoing uncertainty around pricing regulation, which could have a severe impact on future earnings.

Despite the government playing a huge supporting role in the development of the fibre network, the NZ Commerce Commission is investigating potential pricing regulations that would dampen earnings. A decision in December on copper line pricing has reduced earnings before tax by NZ$20 million on an annualised basis according to the company and based on preliminary discussion paper Chorus anticipates it could be as much as NZ$100 million.

Given this, the company’s outlook appears constrained. Chorus’ outlook for FY14 is for flat or moderately declining growth in earnings relative to FY13. Reasons for this include the pricing restrictions around both copper and fibre products, as well as higher costs predicted in FY14 from higher regulatory and consultancy costs.

These costs threaten margins and add to the existing threat coming from the growing use of mobile data which may be more competitive against Chorus’s fixed line costs.

Foolish takeaway

Chorus still pays a great dividend at 7.6%, but its reliability depends on the income it can generate from charging its customers. For non-residents of NZ the deal is sweetened by a supplementary dividend of NZ$0.027 per share.

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Motley Fool contributor Regan Pearson does not own shares in any companies mentioned in this article.

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