- Inflation pressures supporting Telco pricing power, and market outperformance in 2024 expected to subside
- Orange exposure to the French market (c.45%) at a higher risk of backbook repricing
- 6M 90% Vol at 3YPc2 attractive to add negative delta given price near 5Y highs. RSI79 and full valuation
European telecoms have been one of the best-performing sectors over the last year posting a 30% return, second only to Banks (46%) and outperforming the broader Stoxx 600 (11%) on the back of strong operating-cash-flow expansion. The sector has leveraged high inflation rates in recent years to increase existing customer prices through the CPI indexation of existing contracts (back book) boosting average revenue per user (APRU) with limited customer pushback, as most are locked into contracts, while maintaining competitive new customer rates (front book).
However, the landscape is shifting with Eurozone CPI growth flattening out to around 2% after two years above 5%, with a potential decline from 2025 onward, suggesting that telecos may lose their inflation-based pricing power as the big gap between the front and back book closes as contracts are renewed at lower prices. Analysts estimate that front-book prices have seen significant pressure over the last two years with mobile pricing decreasing by an average of almost 15%, with the pressure more pronounced in the French market where prices have fallen almost 25% on average and up to c.40% for some contract providers, due to fierce competition. The pressure in broadband in the broader European region has been less affected, but nonetheless has fallen by an average of less than 5%, with major EU Telcos seeing drops of c.15%. Despite the drops in prices, APRU has remained resilient due to the CPI index pricing. Although there is limited information on the proportion of back-book customers, looking at the latest Dutch telecom regulators 2024 review of the broadband market, the proportion of back book customers invoiced value is more than 75%, and we believe the market may be underappreciating the pricing risks as the market forecasts c.2% of revenue growth and c.3% EBITDA growth for the sector over 2024-26.
Looking at a single stock names, Orange derives c.45% of its revenue from France, the region facing the largest front book price pressure, while currently charging a c.10-15% premium on similar packages vs. its domestic peers, and although competition has been more focused on mobile, it is also expanding to broadband services. In its 4Q24 results, revenues saw zero YoY growth, driven by the 0.7% drop in France and 1.2% drop in Europe offset by stronger MENA results. Despite the benign growth, the company upgraded its organic cash flow forecast to above EUR3.6bn from EUR3.5bn while still maintaining a 3% growth target in its EBITDA for 2025, which may appear demanding in light of the price pressure and lack of growth prospects in its key domestic market. Looking at valuation, the company is currently trading at a 10.5x PE, a 13% premium to its five-year average, and at the higher end of it historical EV/EBITDA discount to peers, with spot also at range highs and close to levels where price has previously run into resistance.
In terms of volatility, 6M ATM IV at 3YPc8 and 6M 90% Vol at a 3YPc2 is particularly attractive to add negative delta on the stock and see asymmetric risks to the downside given our expectations of price pressures ahead, spot near 5Y year highs an RSI79 and full valuation. We propose Long Sep25 11 Puts at a net cost of 3.4% of underlying (Spot ref:11.6, Fut. Ref:11.3).