5G Leadership And Cost Efficiencies Will Drive Long Term Earnings Resilience

Catalysts

About Spark New Zealand

Spark New Zealand provides nationwide mobile, broadband and business connectivity services, alongside selected cloud and IT solutions.

What are the underlying business or industry changes driving this perspective?

• Refocus on core connectivity, with 70% of revenue and 80% of gross margin already coming from mobile, broadband and business connectivity, should support more disciplined capital allocation and may lift group EBITDAI and returns over time.
• 5G stand alone leadership and the planned launch of satellite to mobile services in 2026 position Spark to capture structurally rising data demand and new use cases, supporting mobile service revenue and potentially improving asset turnover.
• Long duration global partnerships with Nokia, Infosys, HPE and Microsoft, combined with expanding AI deployment, are set to structurally lower operating and product costs, aligning with the NZD 110 million to NZD 140 million annualised savings target by FY 27.
• Ongoing migration from legacy voice and private infrastructure to public cloud, collaboration and IoT, now at around 2.4 million IoT connections, is intended to gradually replace declining legacy revenues with higher growth, software rich services that may support more resilient earnings.
• Balance sheet strengthening through the Connexa, HTAL and data center transactions, with net debt to EBITDA targeted to fall by around 0.5 times, is expected to reduce interest costs and risk and to allow a higher proportion of future cash flows to be available for free cash flow and dividends.

Assumptions

How have these above catalysts been quantified?

• Analysts are assuming Spark New Zealand's revenue will remain fairly flat over the next 3 years.
• Analysts assume that profit margins will increase from 6.8% today to 8.1% in 3 years time.
• Analysts expect earnings to reach NZ$302.1 million (and earnings per share of NZ$0.16) by about December 2028, up from NZ$252.0 million today. However, there is a considerable amount of disagreement amongst the analysts with the most bullish expecting NZ$402.8 million in earnings, and the most bearish expecting NZ$255.0 million.
• In order for the above numbers to justify the price target of the analysts, the company would need to trade at a PE ratio of 24.6x on those 2028 earnings, up from 16.9x today. This future PE is lower than the current PE for the AU Telecom industry at 504.2x.
• Analysts expect the number of shares outstanding to grow by 3.3% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 7.53%, as per the Simply Wall St company report.

Risks

What could happen that would invalidate this narrative?

• Persistently weak macroeconomic conditions and structurally lower customer spending on telco and IT services in New Zealand could cap demand for mobile, broadband and IT projects, limiting Spark New Zealand's ability to grow top line connectivity revenue and slowing earnings expansion over the longer term, which would challenge a rising share price driven by revenue growth.
• The secular decline in legacy voice and managed data services, combined with margin pressure from the mix shift to lower margin public cloud and intense price competition in Enterprise and Government, could more than offset growth in mobile, IoT and collaboration, dragging on group gross margin and net margins and constraining long term earnings growth.
• Heightened and ongoing price competition across consumer prepaid, Enterprise and Government mobile and broadband, including aggressive low end offers and new Chorus low price fibre tiers, could force Spark New Zealand to trade off ARPU for volume, putting sustained pressure on mobile and broadband service revenue and limiting improvement in free cash flow and dividends.
• Reliance on large scale technology partnerships and aggressive cost reduction targets to deliver NZD 110 million to NZD 140 million in annualised savings by FY 27 introduces execution and service quality risk. Any under delivery, inflation in partner costs or customer experience issues could erode the expected uplift in EBITDAI, ROIC and long term earnings.

Valuation

How have all the factors above been brought together to estimate a fair value?

• The analysts have a consensus price target of NZ$2.88 for Spark New Zealand based on their expectations of its future earnings growth, profit margins and other risk factors.
  
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of NZ$3.6, and the most bearish reporting a price target of just NZ$2.2.
  
• In order for you to agree with the analysts, you'd need to believe that by 2028, revenues will be NZ$3.8 billion, earnings will come to NZ$302.1 million, and it would be trading on a PE ratio of 24.6x, assuming you use a discount rate of 7.5%.
  
• Given the current share price of NZ$2.25, the analyst price target of NZ$2.88 is 21.7% higher.
  
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.