Those of us old enough to remember Telecom Australia will recall that it was synonymous with poor service and issues with its copper network. In some respects not much has changed since Telecom Australia became Telstra (ASX:TLS) on 1 July 1995.
But to be fair, the last 21 years haven’t all been a disaster. Telstra has benefited from the digital era. The company has long been considered the leader in both fixed and mobile network quality, whether measured by speed, reliability or geographic coverage. This gave Telstra an important competitive advantage over its rivals and enabled it charge more.
However, Telstra’s reputation for network quality might be coming to an end. There have been outages across both its fixed and mobile networks, including seven since February this year. One can only speculate as to what has gone wrong and who knows whether management is on top things yet. But what makes this change in reliability so surprising is that Telstra still spends so much money on its network.
At its annual result this Thursday, Telstra is expected to announce that it has forked out approximately $4.2 billion in capital expenditure, or capex. This equates to around 15% of sales, which is above the global average for a telecommunications company. If Telstra’s capex as a percentage of sales was in-line with global peers it would generate an additional $500 million of cash.
What’s even more surprising is that this year’s capex represents a step-up from what it used to spend. For years, Telstra’s capex was remarkably consistent at 14% of sales. It even dipped slightly below this in 2014. Go back five years and many shareholders would have hoped that Telstra’s capex would be a lot lower by now. Why? Because as the National Broadband Network (NBN) is rolled out, much of the capex required to maintain the new fixed network is taken out of Telstra’s hands.
There could be a number of reasons why Telstra spends more capex per dollar of sales than its global peers. Perhaps it’s attributable to Australia’s vast geographic size and sparse population. Perhaps Telstra’s network is older and needs more maintenance. Whatever the reason, high capex surprisingly hasn’t translated into a reliable network over the last few years. Should this continue, Telstra’s key competitive advantage will be lost and its pricing power will likely disappear with it.
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Forager Funds is a boutique fund manager specialising in a value investing approach. We offer an ASX listed Australian Shares Fund as well as an International Shares Fund both aimed at delivering returns for long term investors.