TalkTalk's 'limited upside' not worth the profit pain for RBC

TalkTalk's fixed low price plan is driving new subscriptions but as margins are being squeezed and profitability unlikely to return until early next year, RBC Capital Markets felt the risks on the stock outweigh "the limited upside".

RBC downgraded the stock to 'sector perform', reversing its upgrade in May, and cut its share price target to 190p from 225p, as it lowered its EBITDA estimate by 9% for the current year to £260m and by 8% for 2019.

The telecoms group has started to grow broadband subs, with 46k net adds in the first half, which is forecast to lead to 118k for the full year, which is a dramatic improvement from the losses in the last two years.

"While this increasing base starts to drive revenue, the top line improvement does not flow through to profitability due to [subscriber acquisition] costs and increasing fibre penetration which squeezes margins," RBC said.

Assuming that gross adds must have been much better, a cost of £170 estimate per gross sub means a turnover of 700k subs accounts for around £120m of annual costs.

"While clearly a 'good' cost, it depresses profitability nonetheless. This can be an issue if churn remains high as the benefit of higher gross adds is lost but the cost remains," RBC said.

Fibre costs are another margin squeezer, with customers migrating to the FLPP using the saving to upgrade to fibre adding additional costs, while TalkTalk also launched Phase 2 of the York fibre build three weeks ago in a joint venture with CityFibre and Sky. This will see 40k homes added, with Talk covering the cost of around £16m and expected to wholesale to Sky.