Telefonica (TEF) Q2 2014 Results – Earnings Call Transcript

Telefonica, S.A. (NYSE:TEF)

Q2 2014 Earnings Conference Call

July 31, 2014 8:00 AM ET

Executives

Pablo Eguirón – Head, IR

Ángel Vilá – CFO and Corporate Development Officer

Analysts

Georgios Ierodiaconou – Citi

Giovanni Montalti – UBS

Akhil Dattani – JP Morgan

Paul Marsch – Berenberg Bank

Justin Funnell – Credit Suisse

Luis Prota – Morgan Stanley

Fabián Lares – JB Capital Markets

David Wright – Bank of America

Jean-Francois Paren – Credit Agricole

Jerry Dellis – Jefferies

Nick Brown – Goldman Sachs

Keval Khiroya – Deutsche Bank

Operator

Good day, ladies and gentlemen. Thank you for standing by and welcome to Telefonica’s January to June 2014 Results Conference Call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session. (Operator instructions) As a reminder, today’s conference is being recorded.

I would now like to turn the call over to Mr. Pablo Eguirón, Head of Investor Relations. Please go ahead, sir.

Pablo Eguirón

Good afternoon, and welcome to Telefonica’s conference call to discuss January-June 2014 results. I’m Pablo Eguirón, Head of Investor Relations.

And before proceeding, let me mention that this document contains financial information that has been prepared under International Financial Reporting Standards. This financial information is valid [ph]. This presentation may contain announcements that constitute forward-looking statements, which are not guarantees of future performance and involve risk and uncertainties. Certain results may differ materially from those in the forward-looking statements as a result of various factors. We invite you to read the complete disclaimer included in the first page of the presentation, which you will find in our website.

We encourage you to review our publicly available disclosure documents filed with the relevant securities market regulators. If you don’t have a copy of the relevant press releases and the slides, contact Telefonica’s Investor Relations team in Madrid by dialing the following telephone number, 3(491)-482-8700.

Now, let me turn the call over to our Chief Financial and Corporate Development Officer, Mr. Ángel Vilá, who will be leading this conference call.

Ángel Vilá

Thank you, Pablo. Good afternoon, and welcome to Telefonica’s first half 2014 results conference call. Today with me is Jose Maria Alvarez-Pallete, Chief Operating Officer. So during the Q&A session, you will have the opportunity to address to us any questions you may have.

Telefonica has released today a strong set of results based on the execution of the management priorities established for the year. First, the quarter evidenced a pickup in commercial activity with remarkable momentum in net add, especially Pay TV, mobile contract, smartphones and fiber. We are working on expanding customer value by reducing churn and improving ARPU.

Second, top line grew year-on-year for the fifth consecutive quarter boosted by Telefonica’s Hispanoamerica growing at double-digit and mobile data ongoing expansion.

Third, OIBDA was stable year-on-year. Financing increased their force in commercial expenses with cost savings from efficiencies. As such, OIBDA margins posted a limited decline year-on-year in organic terms both in the semester and in the quarter.

Fourth, spending for network differentiation continues to accelerate. If financial flexibility was sustained benefiting from a strong free cash flow of EUR1.7 billion in the six months to June while net debt stood at EUR43 million after the sale of Ireland closed in July.

Fifth, EPS posted an outstanding sequential improvement, EUR2.26 per share in Q2.

And finally, let me remark that these results are fully aligned with our expectations and therefore our guidance and dividend policy are confirmed.

Let me now start with a summary of key financials on Slide 3.

Reported first half evolution was impacted by negative FX and the deconsolidation of Telefonica Czech Republic. Although in Q2, both impacts slowed down slightly. The first factor, FX, is at 7.9 percentage points in the semester and 10 percentage points in the second quarter to revenue and OIBDA variation. But at the same time, reduced the payments in euros of CapEx, interest, taxes and minorities; therefore, the FX impact on OIBDA is virtually neutralized at free cash flow level.

In organic terms, second quarter revenues posted a consistent performance versus the first quarter, growing 1.3% year-on-year to reach EUR25 billion in the first half, while OIBDA topped [ph] EUR8.1 billion and remained flat. OIBDA margins stood at 32.3%, 50 basis points lower than in the first six months of 2013.

Lastly, net debt stood at EUR43.8 billion at the end of June, EUR6 billion lower than last year’s figure.

On Slide 4, I would like to stress that commercial activity ramped up showing very strong volumes. This way, total net add exceeded EUR2.6 million, growing 40% quarter-on-quarter and posting a better trend in most categories, but especially in high value services such as mobile contract, Pay TV and fiber.

We continue to focus on value and growth levers, as I just said, increasing customer loyalty on the back of customer differential propositions. This strategy translated into a sequential improvement of churn levels across the board.

Slide 5 shows the remarkable growth of future key drivers, highlighting Pay TV momentum up 32% year-on-year. Connected fiber accesses double year-on-year and LTE coverage in Europe reached almost 50% of the population. Smartphone traction continues and penetration expanded 8 percentage points year-on-year to 32%. As such, the strong investments in customer expansion enable to improve customer satisfaction and differentiation, setting the stage for further sustainable growth.

Best in class portfolio diversification by geographies and services underpinned organic revenue growth as shown in Slide #6. In first half of 2014, Telefonica’s Hispanoamerica and Telefonica Brazil remained as key growth areas, more than offsetting the wholesales by some of our European businesses.

Let me also highlight mobile data revenues which accelerated revenue growth in Q2 to 9.2% year-on-year and increased the weight of our mobile service revenues to 40% which is 3 percentage points up year-on-year.

Revenue flow coupled with good progress on cost-efficiencies allowed the cumulative for EBITDA to remain flat year-on-year organically. Margin declined 50 basis points year-on-year in the first six months and 60 basis points in the second quarter, reflecting higher customer investments linked to capture future growth.

In Slide #7, free cash flow generation was robust in the six months to June, reaching EUR1.7 billion or exceeding EUR1.8 billion before spectrum payments. I would like to highlight the 14.7% year-on-year growth in free cash flow, levered on improvements in most categories of free cash flow metrics. Despite adverse FX effects, CapEx increased on assets sold.

Let me remind you that the first half of the year is traditionally impacted by seasonal effects. Therefore, free cash flow should record a better performance in the second half.

We continue to invest strongly to improve quality and capacity and foster growth, as shown on Slide 8. On network, we keep on accelerating use of broadband deployments in order to meet steady increases. 4G is increasingly available for customers in key markets.

With recent new launch in [indiscernible] on fiber, we have doubled the size of the network, having impact [ph] more than 10 million premises. We are exploiting technology to provide the best data experience, combined with multiple initiatives which are leveraged on our scaling. One example is the global management of roaming traffic already in place in our major markets.

IT is helping businesses transformation according to common principles, such as standardization, modernization, reutilization and automatization. We give you some examples. We launched more business support projects across Telefonica’s Hispanoamerica and we are strengthening our digital capabilities for marketing and self-care.

Finally, efforts on simplification and consolidation continue. With more than 6% of physical servers review, over 160 applications decommissioned, three additional data centers closed and sustained progress progression on virtualization.

Turning to Slide #9, let me go through the main progresses achieved in the digital arena. In the B2B area, solid year-on-year growth rates are shown in different services. Machine to Machine is growing by more than 50% on solid access trends and key deals signed in the first half. Cloud revenue was up 20%. And information security surpassed 40% increase. With relevant agreements reached this quarter such as the one with Etisalat.

Regarding the consumer segment, video stood as one of the key drivers. With revenues accelerating above 15% year-on-year, as we continue to focus on reinforcing our position with exclusive content acquisition.

The global device management is driving the smartphone adoption with special focus on LTE as the total volume of LTE increased eightfold year-on-year.

Finally in financial services I would like to highlight the launch of Yaap Shopping in Spain allowing customers some stores to be connected to discount offers and loyalty program.