Why UBS just put a buy rating on Telstra Corporation Ltd (ASX:TLS) shares

Source: Telstra presentation

Expectations are building ahead of Telstra Corporation Ltd’s (ASX: TLS) results next Thursday with investors keenly awaiting signs that the worst of the earnings squeeze is over for our largest telco.

There might be some good news from UBS on this front. The broker has surveyed consumers on the upcoming launch of TPG Telecom Ltd’s (ASX: TPM) mobile service and found a lukewarm response to the offering.

That’s significant because the new TPG service, which offers unlimited mobile data on a $10 a month plan, is one key reason behind the 30% plus crash in Telstra’s share price.

As it turns out, only 8% of the 1,858 respondents to UBS’ survey said they would “definitely subscribe” to TPG, while 17% indicated they would “probably subscribe” to the service when it is launched later this calendar year.

The broker said it was surprising that not more consumers expressed interest in signing up to TPG given that its plan would be significantly cheaper than rival plans, such as Telstra’s $69 a month plan that offers a similar data allowance.

“For those not interested in subscribing to TPG’s new mobile offering, network/service quality (incl. geographic coverage) and a lack of voice/SMS were the main concerns,” said UBS.

“We also note that TPG’s very limited geographic coverage when it launches might limit early take-up of its new mobile plan further, below the [percentages] suggested above (we note respondents were presented with a plan that worked beyond TPG’s initial rollout area).”

UBS is expecting TPG’s mobile service to gain a 9% market share. This is enough for TPG to reach breakeven on an earnings before interest and tax (EBIT) basis but this penetration rate won’t be enough to justify the investment based on net present value.

Telstra is the worst performing blue-chip stock on the S&P/ASX 200 (Index:^AXJO) (ASX:XJO) index in FY18 as investors fret over an earnings decline that would also threaten its sacred dividend payout.

TPG has already rocked the industry and has prompted the three network operators – Telstra, Vodafone and Optus – to drastically increase data allowances on their plans, while third party resellers cut the prices on their plans.

UBS has a “sell” recommendation on TPG with a price target of $5.30 a share and a “buy” rating on Telstra with a target price of $3 a share.

The market is expecting Telstra to announce a cut its dividend to 18 cents a share for FY19 from 22 cents a share when it hands in its earnings report card.

If Telstra can produce a slightly better-than-expected dividend for the current financial year and prove that this is sustainable despite the challenges, the stock will re-rate.

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Motley Fool contributor Brendon Lau owns shares of Telstra Limited and TPG Telecom Limited. The Motley Fool Australia owns shares of and has recommended Telstra Limited and TPG Telecom Limited. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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