- Telco outperformance over the last month driven by US tariff fears rather than fundamentals
- Broadband customer losses increasing in both Openreach and B2C, outpacing the loss of previous years
- Spot trading at the upper end of price channel. Valuation rich at 7.2x P/E, a 21% premium to its 5-year average
Following our recent note related to the looming tariff risks, 2nd April – binary event risk for EU lines, we draw attention to European Telcos, which have outperformed the broader market, posting a +12% YtD return vs. +8% for the STOXX 600. Looking at price performance, although the sector moved in line with the market for the first two months of the year, on the back of the broader rotation out of the US into European assets, outperformance over the last few weeks has been driven by a turn to defensives ahead of the 2 April tariff announcement (Fig. 2), as the sector is unaffected by tariffs. We believe the move is disconnected from worsening fundamentals in the sector, namely: 1) deteriorating revenue growth; 2) high pricing power, particularly in corporate segments; 3) smaller challenger Telcos growing market share; and 4) divergence of backbook prices towards significantly lower frontbook prices.
Looking at single names, BT Group faces intensifying competition and structural challenges in the UK telecom market as the rise of alternative fiber providers has been eating away market share in its Openreach division, which has historically been a cornerstone of its dominance (currently 25% of Group revenue vs. 41% in 2014 – Fig. 5). According to a September 2024 report from ISPreview, over 70% of the UK now has access to full-fibre broadband, with alternative providers like CityFibre and Hyperoptic aggressively expanding their networks. The rising competition is already reflected in the performance of Openreach, which lost 208k broadband lines in the last quarter of 2024 (Fig. 7), significantly higher than the 164k expected by the market in what appears to be an acceleration of customer losses vs. previous years (total broadband line loss: 2024 709k vs. 2023 437k). Analysts expect that Openreach broadband line losses could surpass 770k in FY25 and 650k in FY26. Pressure is also seen in its consumer division (42% of Group revenue), where despite the modest 0.4% service revenue growth, its broadband customer base also shrank by 40k, with the pace of losses increasing similar to in its Openreach division (Fig. 7), with decreasing growth also seen in average revenue per user (Fig. 6).
The company also faces regulatory headwinds as the UK’s Ofcom has proposed measures to level the playing field, including price caps and easier switching rules, which could further squeeze BT’s margins, while its corporate segment also faces risks from the merger between Vodafone and Three. In light of the ongoing pressures, BT’s returns on its planned EUR15bn full-fiber rollout may not be as attractive as expected, and its EUR3bn free cash flow target by decade’s end appears optimistic. We also note that the company already revised its FY25 revenue guidance downwards at its CY3Q24, reflecting weaker trading.
In terms of technicals, spot is trading at the upper end of its price channel (Fig. 3) of the last two years while valuation also appears rich at 7.2x P/E, a 21% premium to its 5-year average (Fig. 4). With 3M ATM volatility undemanding at 3yPC22, we propose Long Jun25 145 Puts at a net cost of 1.6% of underlying (Spot ref: 164.7, Fut. ref: 165.5).