Telefónica Q2 2023 Earnings Call Transcript

Quartr
Provided by Quartr
July 27, 2023

There are 12 speakers on the call.

Operator

Good morning. Thank you for standing by, and welcome to Telefonica's January June 2023 Results Conference Call. At this time, all participants are in a listen only mode. Later, we will conduct a question and answer session. As a reminder, today's conference is being recorded.

Operator

I would now like to turn the call over to Mr. Adrian Suntunegui, Global Director of Investor Relations. Please go ahead, sir.

Speaker 1

Good morning, and welcome to Telefonica's conference call to discuss January June 2023 results. I'm Adriant Tom Foneggi from Investor Relations. Before proceeding, let me mention that the financial information contained in this document has been prepared under International Financial Reporting Standards as adopted by the European Union. This conference call and webcast, including the Q and A session, may contain forward looking statements and information relating to the These statements may include financial or operating forecasts and estimates or statements regarding plans, objectives and expectations regarding different matters. All forward looking statements involve risks and uncertainties that could cause the final developments and results to materially differ from those If you don't have a copy of the relevant press release and the slides, please contact the Fonica's Investor Relations team in Madrid or London.

Speaker 1

Now let me turn the call over to our Chairman and CEO, Mr. Jose Maria Aalores Palliete.

Speaker 2

Good morning, and welcome to Telefonica's With me today are Angel Villa, Laura Bassolo, Eduardo Navarro and Luc Schueller. As usual, We will first take you through the slides and we'll then be happy to take your questions. During the Q2, We continued to focus on our strategic objectives and delivered on our goals. We improved our position in all core markets. In Spain, Retail revenue growth improved and we progressed towards OIBDA stabilization.

Speaker 2

In Brazil, OIBDA minus CapEx performance was outstanding With more than 30% annual growth, while revenue grew above inflation, thanks to a strong operational performance. In Germany, the first half results showed a strong performance and continued momentum with excellent progress in 5 gs deployment to 90% PoP coverage in a normalized CapEx to sales envelope. Finally, in the UK, we accelerated the network rollout in ultra broadband And 5 gs, along with a sequential improvement in revenue and OIBDA growth based on synergies, which we are executing above plans. We see opportunities from in market consolidation in Spain and the UK over the next years. In Spain, copper switch off in April 2024 is an important milestone.

Speaker 2

In Brazil, We focus on growth and lower capital intensity and the B2C ecosystem opportunity. In Germany, good customer demanding of more for more tariffs Underpins future growth ambitions. And in the UK, we will benefit from synergy realization until 2026. Group wise, Telefonica Tech continues to outgrow its market with solid revenue growth and continued to be a source of value, While Telefonica Infra further develop our fiber vehicles and looks for consolidation opportunities. Telefonica Ispan announced Two important deals, the MoU network sharing agreement in Colombia with TIGO and the agreement with KKR and Enel Chile to Create the largest neutral wholesale fiber co in Peru.

Speaker 2

32 telcos have already joined Open Gateway initiative, And we are fostering the development of artificial intelligence based use cases. Finally, from a regulatory point of view, The next months are key for fair share regulation and consolidation among others. Please turn to Slide 3 for our 2nd quarter results that show increasingly profitable and sustainable growth. This is The 5th consecutive quarter of reported revenue growth, thanks to a strong commercial momentum in value accesses, backed By increasing coverage of next generation networks that helps us strengthening the relationship with our customers with sustained high NPS levels, Along these lines, service revenue grew 3.4% year on year, showing the pricing power we built in our business. B2B that grows 6.9% year on year remains a strong driver as well as we continue to outgrow both our peers And the markets in which we operate.

Speaker 2

The above also results into low churn levels with coupled with cost efficiencies and digitalization measures helps to improve organic OIBDA growth sequentially as much as 2.4 percentage points versus the last quarter to 3.5% year on year growth. This trend is visible in all core units. This operating leverage in the business is the main driver behind the higher margin. Contain capital intensity and active management on all free cash flow guidance, notably in our debt cost, helps operating performance to flow through free cash flow, which is almost twice what we generated in the Q1 of the year And growth year on year to EUR 842,000,000 for a total of EUR 1,300,000,000 in the 1st 6 months of the year. To sum it up, improved OIBDA and free cash flow momentum.

Speaker 2

Moving to Slide 4 for detailed financial update. In organic terms, revenue, OIBDA and OIBDA minus CapEx grew in the 2nd quarter by 3.3%, 3.5% And 3.4%, respectively. In reported terms, revenue grew 0.9% year on year and OIBDA was stable despite The negative FX impact this quarter. Net income increased 44.5% in the Q2 of this year to EUR 462,000,000, reaching EUR 760,000,000 in the first half of the year. Free cash flow reached EUR 842,000,000 in the quarter And EUR 1,300,000,000 in the first half of the year, while June net financial debt declined 3.9% year on year to EUR 27,500,000,000.

Speaker 2

Moving to Slide 5. We show a strong first half of the year performance and the expected evolution of our business. Thanks to a strong commercial and operating momentum, give us confidence to upgrade our group guidance for this year. We are moving up From our previous guidance of low single digit growth for both revenues and OIBDA to organic revenue year on year growth of around 4%, Organic OIBDA year on year growth of around 3%, while we keep our CapEx II sales organic guidance unchanged at around 14%. This upgraded guidance at both revenues and OIBDA coupled with unchanged capital intensity levels Make us extremely confident with free cash flow generation for the year.

Speaker 2

We expect We stand above latest consensus estimate and generate significantly more free cash flow in the second half of the year for a full free cash flow figure that excluding Spectrum should not be far from the EUR 4,000,000,000 mark. Furthermore, we will propose to the shareholders meeting the adoption of the corresponding corporate resolution For the cancellation of 1.4 percent of shares held as treasury stock at the 30 June 2023. This, Together with our confirmed EUR 0.3 per share dividend implies a very attractive shareholder remuneration scheme, a consequence Forward strong confidence in our free cash flow generation capacity. Turning to Slide 6, I would like to provide a glimpse of our progress across the pillars of ESG. On the environmental side, VM02's Net 0 targets has been validated by the renowned Science Based Targets initiative, a validation received by Telefonica Group last year, The first in the sector to achieve it.

Speaker 2

We have also introduced take back, reusing and recycling targets, In line with the sector push to address the circularity of devices. With regard to the social pillar, we continue to connect more people directly And via network agreements to improve and extend coverage. We also helped to boost around 1,200,000 people's employment prospects via our foundation. Within the company, women now represent just over 32% of executives, positioning us well on track to achieve our 2024 target of 33%. On the governance side, we highlight the award by Global Capital for our sustainable finance issuance, the launch of our ESG Academy to provide training for our employees and that we are protecting our customers from cyber attacks.

Speaker 2

I will now hand over to Angel to give you an overview of the progress across the operating business.

Speaker 3

Thank you, Jose Maria. Moving to Slide 7, we review Telefonica's paying performance. Q2 results again confirmed a stronger commercial momentum And OIBDA trend improvement. Fixed broadband and contract customers simultaneously grew year on year for the first time since the pandemic. Our leading churn remained at historic lows and our industry leading convergent ARPU kept growing year on year.

Speaker 3

NPS remains best in class and increased by 10 percentage points year on year to 48%. This allowed us to increase customer lifetime by 23% year on year to 9 years. All this proves the leading position of Movistar in a competitive but rational market and the benefits of our strategy to focus on value share. As such, we continue to build on our smart bundling experience and premium Recently, we have announced the update of our conversion portfolio adding more value and the launch of a new over the top proposal, Another step to further boost commercial activity and top line growth. Service revenues in the 2nd quarter maintained momentum, While retail revenue year on year growth accelerated by 0.2 percentage points versus the Q1 on the back of tariff updates, improved commercial activity and sustained double digit growth in IT revenues.

Speaker 3

OMTA declined slow to minus 1% year on year, And it is progressively stabilizing, plus 0.7 percentage points improvement versus Q1, driven by lower content costs and network transformation efficiencies, all of which gives us confidence to continue aiming For stabilization at some point in the second half of the year. OIBDA minus CapEx margin remained at benchmark low levels, Despite the higher CapEx intensity in Q2, which will soften in the second half of the year. Moving to Germany on Slide 8, which continued its robust growth path with another quarter of good operational traction and sustained financial performance. The company implemented its more formal strategy across all brands and portfolios, which has been well received by customers. There has been good commercial traction on the back of strong own brand momentum and normalized churn rates.

Speaker 3

Telefonica Deutschland made good progress with the densification and further rollout of its 5 gs networks, All within a normalized CapEx envelope. As a result, 90% of 5 gs PoP coverage target Set for the year was already achieved in Q2. Organic revenue was up 4.4% year on year, while OIBDA grew 2.8 percent year on year, accelerating 1.1 percentage points quarter on quarter, supported by improved operational leverage, mainly mobile, which was partially offset by anticipated cost increases. Finally, the company narrows The full year 'twenty three revenue and OIBDA outlook to upper range of low single digit growth We now move on to Slide 9 to the UK and our joint venture Virgin Media O2 that continues to focus on expanding the ultra broadband network, which now covers a total of 16,400,000 premises and with 5 gs connectivity now available In over 2,800 towns and cities, amidst the tough economic climate, fixed and mobile price rises were During April May and are starting to flow through to Q2 figures. O2 mobile contract churn showed improvement to 0.9% driven by loyalty initiatives.

Speaker 3

Revenue growth accelerated to 6.2%, while Swede reached 3.7%, OIBDA performance reflects ongoing synergy realization, which stands above plans and which will support future OIBDA growth. VMO2, within its ambitious better connections plan, Has announced a reduction in carbon emissions of 29%, scope 12 against the 2020 baseline and its net zero targets across the value chain were validated by SVTI. Moving to Brazil on Slide 10. Vivo continued to achieve very strong results Despite Oi deal amortization since Q2, 2023. We have been consistently increasing our market share Since the Oi Mobile acquisition, reaching a mobile market share of 39% or 44% in the contract segment.

Speaker 3

The improvement of the accesses quality, coupled with upgrading and price increases results in 8% growth in mobile ARPU, While contract churn continued its declining trend to 1%, its lowest level ever. Revenue grew by 7.6% year on year in Q2 2023, well above inflation, which together with cost And the reduction in CapEx intensity allows us to deliver an exceptional plus 29.2 percent year on year growth Fornicatech, our leading IT provider for B2B digitalization. TTEC has completed a 3 year cycle as a fully operational company, Achieving a leading position as a provider of high value integrated solutions in EMEA and the Americas. Telefonica Tech is now entering a new cycle With a new organizational model. In Q2, 2023, businesses and portfolio have been unified to provide the best service And maximize opportunity in all markets.

Speaker 3

Cloud will be the enabler of IoT, Big Data and AI And cybersecurity will be embedded in all the processes. This new operational model, together with the global extension of capabilities, We'll create synergies and make Telefonica Tech more efficient and further increase its contribution as a key differential growth driver for Telefonica's In Q2, Telefonica Tech outperformed the market again with 36% year on year revenue growth. In constant perimeter, revenue growth accelerated by 2 percentage points to 29% year on year. Our highly skilled team of over 6,000 professionals with close to 4,000 certifications in Strategic Partners Technologies Continue to be the key asset for Telefonica Tech to deliver a differentiated digitalization journey. Our visibility of future revenue is high, supported by an increase in last 12 months bookings of 35% year on year.

Speaker 3

On Slide 12, at Telefonica Infra, we crystallized the value of our assets and capabilities. First, we continue to execute and scale up our fiber plants And have already passed 19,000,000 premises in underserved and or low density areas after incorporating Pangiago in Peru. Telefonica Infra continues adding to Telefonica Group leading worldwide position in fiber to the home deployment. A few weeks ago, Telefonica ISPM reached an agreement with KKR and Entel Peru and will hold 36%, 54% and 10% stakes, respectively, In the new fiber company, it will be the 1st nationwide open access wholesale fiber co with a target of passing 5,200,000 premises at the end of 2026 doubling the current footprint. To highlight also that NextFibre in the UK is in June commercially live And consumers can already connect to NextFibre's hyperfast network with the latest XS GPON architecture.

Speaker 3

TELSIUS, The critical digital infrastructure with 7 next generation subsea cables built since 2018 posted the 6th Consecutive quarter of organic OIBDA growth and expanded OIBDA margin by 1.7 percentage points to 53% I will now hand it over to Laura, who will review Hispam's operations and the group financial results.

Speaker 4

Thank you, Angel. Moving to Telefonica's Spain. We continue with the execution of our strategy to reduce the exposure to the region and make the business more profitable. On June 12, Telefonica Colombia signed an MoU with Millicon for sharing the mobile access network in Colombia. This agreement will help improve the quality of mobile services and lead to a more efficient use of resources.

Speaker 4

In addition, Telefonica Ispan reached an agreement with Panjiaco in Peru, as Angel mentioned before. Overall results were solid. Revenues were virtually stable year on year despite a tough competitive environment, while OIBDA continues to be affected by the growth of commercial costs driven by fiber commodity. However, we expect a better OIBDA trend in the next quarters and we maintain our ambition to grow OIBDA minus CapEx in 2023. Turning to Slide 14.

Speaker 4

Telefonica maintains above 80% of its debt linked to fixed rates, mainly in euro, with an average life of 12.4 years, which places us in a comfortable position to face any market environment. We maintain a solid liquidity position of €20,200,000,000 that together with a line maturity profile allows us to cover debt maturities over the next 3 years. Meanwhile, net financial debt declined from EUR 28,600,000,000 in June 2022 to EUR 27,500,000,000 in June 2023. Net debt to EBITDA ratio improved from 2.79 to 2.62 times in the same period. We have also contained our debt related interest costs at 3.47 percent, Thanks to the active refinancing exercise undertaken along previous years and the solid position at fixed interest rates in strong currencies that allows immunization to I will now hand back to Jose Maria, who will explain the completion of our transformation journey and wrap up.

Speaker 2

Thank you, Laura. Now at the end of the presentation, let me talk about the transformation process we have gone through, enabling us to deliver these strong results and allowing us to update the guidance and making us feel optimistic about the future. At Telefonica, we have always been at the forefront of technological change To ensure our success in the future, change is on our DNA. We transform the way we serve our customers, Turning our customers into next generation infrastructure that transport more and more data with systems that store more and more information With massive processing capacity, we were early to invest in fiber and 5 gs and are now the 1st scale telecom operator to shut down its But that is just the most visible technological change. We have virtualized and softwareized our networks and use AI since several years ago.

Speaker 2

We are now at a stage where we can do real time service customization And are able to offer network as a service and network slicing. Technology has helped us transform our revenue functions, We now generate 75% of our revenues from ultra broadband connectivity and digital services, up from 46% in 2015. We made our organic revenue grow again for the last nine quarters. We grow in B2C where we hit record lows in churn levels, When at the same time, NPS has never been higher, thanks to this new way of to interact with customers. We built digital ecosystems to capture new revenue opportunities.

Speaker 2

We have outgrown both our peers and the market in B2B, We have increased our wholesale capacity. We have as well transformed our OpEx and CapEx functions. 83% of our processes are now digitized from 50% back in 2016. We have taken huge steps in virtualization, softwareization and automation towards 0 touch networks. Capital intensity continues trending downwards From 16.7% back in 2016 to 40% at the end of 2023.

Speaker 2

Deployments are mostly behind And legacy shutdowns are mostly digested. With this technological transformation, we have positioned ourselves to fully benefit from the next wave of growth And emerging business opportunities. We are ready for the future. Moving to Slide 16. We have further confidence in our ability to continue to deliver strong and growing free cash flow generation in the coming years.

Speaker 2

To be precise, We are projecting free cash flow growth in the next 3 years strategic plan, which we plan to detail in our Capital Markets Day to be held in Madrid on November 8, together with our Q3 results release. As said, free cash flow growth is the ambition behind this new plan, on which we have been working since late last year based on these three main pillars: Our company and sector vision, including a new company program based on growth, profitability and sustainability. With our customers at the center, Through technology and automation, we will continue to have a better understanding of our customers' needs and create better customer experiences, Always aiming at long term satisfaction with customer empathy at the core. Technology and AI to continue the transformation process At Telefonica, we have been using technology for years to shape our company for the future. We will continue doing so both internally and externally.

Speaker 2

With efficiency as the ultimate driver of decisions and a clear focus on free cash flow growth to increase financial flexibility, reduce leverage And reward shareholders. Key levers behind free cash flow growth are the following: revenue growth, We are growing again our revenue since the Q2 of 2021 organically. We aim to maintain this strong momentum backed By a growing digital business, including tech and digital B2C ecosystem, the ARPU app policies across our B2C operations, Our differential B2B growth and a new API based ways to monetize next generation networks to allow us to continue this path of profitable growth. And again, efficiency. We continue exploring sources of efficiency at both the OpEx and leases level, Deriving from legacy decommissioning, AI driven softwareization of networks and CRM, content optimization and others, which we will share with you at our Capital Markets Day.

Speaker 2

We also aim to continue to optimize CapEx via legacy switch offs, Traffic optimization, AI, softwareization, sharing and others that should allow us to further reduce capital intensity. We are very much looking forward to greeting all of you in our premises on November 8, where we will share all the details. To recap on Slide 17. Q2 posted good earnings momentum and continued to deliver value for our shareholders. 1st, we remain confident in our strategy and in our ability to maximize value for shareholders.

Speaker 2

Revenue and OIBDA grew organically 2nd, we continue to build on our network leadership And remain on track to expand our fiber to the home and 5 gs coverage. Thanks to our pioneering in digitalization and AI applications, We are in the best position to increase efficiency and capture new opportunities such as Open Gateway. Free cash flow improved in the Q2, and we expect this to continue along 2023. As such, we remain committed to maintain an investment grade Credit rating and to leverage reduction. 3rd, guidance for 2023 is upgraded based on the strong revenue and OIBDA momentum.

Speaker 2

We will amortize 1.4 percent of treasury stock and we confirm our dividend for 2023. We expect this strong momentum to continue going forward. Save the date for the Capital Markets Day. We are calling for the next November 8, where we will present our new 2023, 2026 strategic plan and company vision with a clear focus on growing free cash flow. We have been working on this plan for several months, and we are excited about what we are going what we are seeing.

Speaker 2

Full details will be shared then, We have a solid starting point for a bright free cash flow outlook for the next years. Thank you very much for listening. We are now ready to take your questions.

Operator

We will now take the first question

Speaker 5

from the

Operator

line of Yemi Falana from Goldman Sachs. Please go ahead.

Speaker 6

Good morning, everyone. Thanks for the opportunity. A couple of questions from me. Firstly, the Spanish macroeconomic picture is beginning to look uniquely Strong in the European context with improving growth and low inflation, how does that impact how you're thinking about pricing into 2024? And then secondly, maybe a bit more big picture.

Speaker 6

Free cash flow remains strong, and I believe you're now targeting EUR 4,000,000,000 this year, which looks ahead of consensus As far as I can tell, into the CMD, how are you thinking about rewarding shareholders alongside that free cash flow growth? Any kind of High level kind of thought processes that would be super helpful. Cheers.

Speaker 3

The first one on the Spanish macro. We are seeing no impact Of the current economic conditions on any significant way on our performance, you have seen that the first the second quarter or the first half of the year, We have had positive momentum commercially. We have had the highest NPS and lowest churn in spite Of what could be the highest price increases we have passed on to our customers historically, We see this commercial momentum, if anything, improving in the second quarter and revenue clearly has been accelerating. OIBDA has been on a track clearly towards the stabilization that we're aiming at for this year. On the B2B segment, we are also, in particular, which could be in or has been in other moments In the past, feeling the impact of macroeconomic implications, we are seeing a very solid growth in the B2B business.

Speaker 3

[SPEAKER JOSE ANTONIO ALVAREZ ALVAREZ:] So we feel that our business is well adjusted to Manage the evolving macro conditions. Regarding potential pricing implications going forward in the next The year or so, we will adjust to market conditions as we see fit.

Speaker 2

Taking your questions on the free cash flow, as we have been stating, we are starting from a very solid position this year, And we have been mentioning our vision of approaching the EUR 4,000,000,000 mark This year, excluding spectrum. According to the job that we have been doing, we are projecting free cash flow growth for the next year Based on the leverage that we have also shared with you and we intend to use this free cash flow to keep reducing debt, to gain financial flexibility and for sure reward our shareholders. Details will be shared on the Capital Markets Day.

Speaker 6

Awesome. Thanks very much.

Operator

Thank you. We will now take the next question from the line of Keval Khiroja from Deutsche Bank. Please go ahead.

Speaker 7

Thank you for taking the questions. And I have 2, please. So firstly, Q2 showed modest conversion to ARPU growth in Spain, perhaps impacted by the temporary switch off of the football packages. Should we expect conversion ARPU growth to accelerate in H2 versus the 1.5% growth you delivered in the first half? And then secondly, can you share with us how you're currently thinking about leverage?

Speaker 7

On Slide 16, you highlight reduced leverage On the increased financial flexibility within the pillars, where would you like leverage to trend to? And to what degree can inorganic actions help you get there? Thank you.

Speaker 3

Thank you, Keval, for your questions. Regarding convergent ARPU, which is €91.5 gross, 1.5% year on year in the second quarter, driven by Pricing update and fewer promotions. Some other issues remain at the lack as the lower out of bundle consumption, The growing O2 penetration and less advertising contribution. If you compare it quarter on quarter, which I think was Your question, the trend in Q2 is lower than in Q1 due to the more evident decline of auto bundle revenues, some mix erosion, [SPEAKER JOSE ANTONIO ALVAREZ ALVAREZ:] But in particular, it's the end of the football season. We see this every season.

Speaker 3

When summer Disconnections take place at the end of the season and most of the customers join again [SPEAKER JOSE ANTONIO ALVAREZ PALLETE:] At the start of the season, we are aiming to see ARPU to continue having year on year growth in the second

Speaker 4

Yuval, on your question on leverage, as you know, we have a very strong public Commitment to maintain an investment grade credit rating. So leverage, as also Jose Maria said, deleverage remains A priority for us. Our main driver is going to be free cash flow. And not only is very strong and will be very This year, but we also see a growing trajectory for the coming years. That's based on a steady organic OIBDA improvement and the CapEx peak being definitely behind us.

Speaker 4

So you should expect that free cash flow to be the main revenue and also the most It's also very important to mention that we prioritize this Balance is a strength with a very prudent debt management that has allowed us to be very resilient in the current environment. We have a very strong liquidity position and a line maturity profile. And we are anticipating much of the liability management and we really tap the markets at the right moment. On top of that, obviously, we will continue with various strict capital allocation. And inorganically, we could also complement the deleveraging path because we have a top quality asset base, but the main driver is going to be that resilient and recurring free cash flow that you've Seen in the past years and it won't be the exception for the coming years either.

Speaker 8

Thank you.

Operator

Thank you. We will now take the next question from the line of Georgios Gerodiaconou from Citi. Please go ahead.

Speaker 5

Yes. Good morning and thank you for taking my questions. My first question is on free cash flow and I know Probably a lot more details are due to be given at the CMD, but you did highlight the potential for growth going forward. And Laura, you spoke about EBITDA and CapEx drivers. I was wondering if you can also give us Couple of insights as to how we should think about financial costs, which are coming down, even the rate is coming down, whether that is sustainable and what is behind it?

Speaker 5

Also, if you can comment a bit about the recap in the UK, which is a significant driver of your cash flow in 2023, whether That is something we should expect going forward. And any comments on working capital as well will be greatly appreciated. And then my second question is about the UK market, and I know Lutz addressed this at the Conference call the other day around the churn for Virgin being lower than expected in broadband given the scale of the price increases. Just Curious to follow-up given that we have more data points from some of your main competitors. It does look like the market as a whole Might be shrinking or the old nets making more inroads perhaps on previous quarters.

Speaker 5

So just Curious to hear your thoughts which of the two explanations sounds more credible to you. And if it is A case of market growth stalling, whether there's any insights you can share about the timing of any recovery? Thank you.

Speaker 4

Thank you, Georgios, for the question. On free cash flow, indeed, in Q2, it has improved. It has Grow year on year, almost doubling the Q1 figure. And this year is not exception. Free cash flow is usually back end loaded, And we see free cash flow growth accelerating to the end of the year.

Speaker 4

OIBDA minus CapEx We'll be according to our improved guidance. So that's going to be a main contributor. And below that, we will continue optimizing Every line as we do. Working capital, which had a negative impact in this first half of the year, will have A positive impact throughout the year, but that's very much linked to our commercial activities. On financial payments, you should expect us to optimize it as we have done in the past.

Speaker 4

I mean, the Cost per se is one of the KPIs to follow, no doubt, but we also have to find a balance between currency, The life of the debt, the liquidity position and the smooth path of maturity refinancing that we are always Aiming for, no? But I think you should expect us to keep on optimizing them as we have done in the past. We have 80% fixed. And what is variable is more in Hispano and Brazilian currencies, and that should start going down in terms of interest rates. So We feel comfortable with the management we have at the moment and that being able to continue.

Speaker 4

Regarding the UK, no changes. We have guided the JV To stay at the upper end of 4 to 5 times net leverage range, it's a cash generating business with organic and synergy driven opportunities to grow. It has a strong current capital structure. The debt tenure is 6.5 years, excluding vendor finance, and the cost of that debt is 4.7. So it's not forced either to go into debt markets and in opportunity times, no?

Speaker 4

And it's going to have a growing EBITDA, which will lead to natural deleveraging. So as you know, that's going to be in the line. We said at the beginning of the year in that €4,000,000,000 reference we gave for free cash flow in 2023. The cash distribution to shareholders is anticipated to be between £1,800,000,000 to £2,100,000,000 and that's included in our outlook for the free cash flow we provided this morning.

Speaker 9

Yes. On your question regarding the U. K, Georgios, so a year ago, We had a growth of 7,000 customers in Q2 after price rise of 6.8%. This year, we have a price rise of 13.8%, so more than double of it. And we are shrinking by 15,000.

Speaker 9

So the delta is $22,000 between the 2 years while doubling the price rise. So we attribute Really, the delta to the significantly higher price rise. And as you know, The impact of it, in our case, is has materialized entirely into Q2, right, because customers Are having a 30 days cancellation ride, and this obviously is not the case anymore from Q3 onwards. Having said that, when you look at gross adds, I think your observation is right. So the gross adds market is slightly smaller.

Speaker 9

But as I said in the Liberty Global call, we are actually doing better because we have Expected a bit higher reaction on price rise. So all in all, we have been pretty pleased with the overall number. I hope that helps. Maybe last comment, AltNet, well, they're right in areas where they are offering sales at very aggressive promotions. We see some of these impacts that our share and growth rates are lower in these markets.

Speaker 9

We see it significantly less on churn. And we think the reason for that is that the majority of our customers have more than one product, Right. And as you know then, the convergence game is that people are not necessarily switching broadband if they don't have The night video product or mobile product. Thank you.

Speaker 5

All right. That's clear. Thank you.

Operator

Thank you. We will now take the next question from the line of David Wright from Bank of America.

Speaker 10

Thank you very much, guys. I guess just it's 2 follow ons from Georgios, but just Picking on the detail a bit, I mean, when we think about this free cash flow you guys are generating, a lot of it is borrowed, right, effectively from VMO 2. With the borrowing cost of debt, as you've just said, Laura, at the high 4s. So I'm struggling to understand that contradiction with The need to delever, but borrowing at nearly 5% at 2% to support cash that you're paying out to investors. Does it not make more sense to reduce the leverage at 2, which is at a higher blended cost of debt?

Speaker 10

And also given that they Arguably have a requirement to accelerate the CapEx to build fiber over time. So it just seems a contradiction to me that you're Borrowing in the U. K. To pay out in Spain when you should be potentially looking to delever. And then I guess, Lutz, I'm also not understanding your answer there.

Speaker 10

I thought the data that you've given us is only the Q2 customer losses. But I think a lot of those Price rises in the U. K, the announcements were made in May. So there will be more customer losses following in Q3, Q3, well, they're not. You said it was the full impact in Q2, but I think you'll probably get more customer losses in Q3 as that price rise It's phased in.

Speaker 10

Is that not the case too? So just a couple of clarifications there, please. Thank you.

Speaker 4

David, thank you for your question. On the UK and the impact in Free cash flow, it is a part of our free cash flow, no doubt, but not a significant part. I mean, we are guiding on EUR 4,000,000,000. This will be about EUR 1,000,000,000. And you have seen the results of Germany or Brazil or I mean, we have very strong core assets generating very resilient and recurring free cash flows.

Speaker 4

So That's the ballpark, as I said at the beginning and the main driver for deleveraging. As you rightly mentioned, I mean, obviously, The agreement we have among the shareholders on the leverage range was done in a different scenario in terms of interest rates. So definitely, we will Revaluate that, but it's worth mentioning the capital structure of the JV is prudent in terms of life, in terms of cost, In terms of not going in a rush, we were successfully financing ourselves in the 1st part of the year at good cost in the current scenario. But that's something that within our strategic capital allocation decision and free cash flow drivers, we will evaluate Going forward and more important, AOIBDA is growing there and they have a lot of synergies still as we haven't achieved the run rate yet. But we are in a very, very good trajectory and synergies are being delivered as expected.

Speaker 4

So that's but a very important thing, David, is that from a leverage perspective, you know S and P and also Moody's looks at that Number as well, they account for the debt we have in the UK in proportionate basis. So if we had a different mix Between dividend and a less leverage JV from a rating perspective, it will be very much neutral from Telefonica's side. So it is consistent. Whether we continue with the 4% to 5% or we make any changes there, that should be agreed With our partner in the JV that will not affect our rating quality.

Speaker 10

Yes. It just if I may add, it just seems perhaps a little imbalanced because you're effectively Keeping you're borrowing at 5% and your blended cost is 3.5%. Liberty's objectives may be a little different Because they're using the cash to buy back their shares, you're just paying out a dividend. So it just feels that every time you're boosting your cash flow with the distribution, you're actually blending your cost of debt Because you're borrowing that cash at 5%.

Speaker 4

Arith, basically, you are right. And that's why we will definitely take a look at this. But so far, the JV is delivering. So far, The JV is committed to the dividend we had for the year and obviously that will be evaluated. But it was very important to mention that this It is not the way to deleverage the company.

Speaker 4

We are not deleveraging the Telefonica side throughout the dividends from the JV first. If we change the dynamic, we will have a less leverage company from an S and P rating position. So we will be very neutral. And second, our core assets plus growing business units are delivering, and they are the bulk of the free cash flow of

Speaker 10

Okay. Thanks, Laura. And maybe Lutz, just a clarification, please.

Speaker 9

Yes. Sorry for the confusion, David. So I think we have to distinguish a bit here. So we have sent The price increase letters to customers in April May. Customers do have then a 30 day extraordinary cancellation Right.

Speaker 9

Therefore, all of this has happened in Q2. Now 60 days after the customer has Received the price increase letter, the higher prices will be charged with the exception of customers who are still in their promotional period. So they get it then from the beginning of the promotional period, but they don't have another cancellation right when they are getting Charged with higher prices. So therefore, both actually fit very well together. The churn has materialized out of it into Q2, While the vast majority of the revenue is coming in across H2.

Speaker 9

I hope that helps

Speaker 10

That really does clear it up. Thank you very much, Luz.

Speaker 9

Okay. Thanks.

Operator

Thank you. We will now take the next question from the line of Mathieu Robilliard from Barclays. Please go ahead.

Speaker 11

Yes. Good morning and thank you for the presentation. I had a question about the copper switch off, Which obviously you are leading in terms of that process in Europe. And you've mentioned in the past That it could lift EBITDA margins by 1.8%. And I was wondering what would be the impact on CapEx, If you could give us also a little bit of color there.

Speaker 11

And as a follow-up on the copper switch off, I realize that, that means that you get Hands on a lot of copper and my understanding is that you're selling it. And I wanted to understand how material that was in terms of the contribution to EBITDA For the Spanish on the group business. And then a very last one on free cash flow. When you talk about free cash flow excluding spectrum Getting close to €4,000,000,000 I just want to clarify how we should compare that to consensus because indeed I think the latest consensus you published was for SEK 3,300,000,000 of free cash flow. So that would be materially higher, but my understanding is that consensus includes spectrum.

Speaker 11

So I don't know if you can give a little bit of clarification here what would be a like for like comparison. Thank you.

Speaker 3

Thank you, Mathieu, for your questions. I'll take the first one on the copper switch off. As you said in the past, we have quantified That we have already captured what an estimate of 0.8 percentage points in EBITDA margin from permanent efficiencies From corporate commission up to 2022. And we expect further improvements in the next few years, which we could quantify On at least an additional one percentage point on OIBDA. You were taking then the question what does this imply to CapEx.

Speaker 3

We already Clearly, past the CapEx peak in Spain, you have seen that the CapEx intensity of our Spanish operation is well below [SPEAKER JOSE ANTONIO ALVAREZ PALLETE:] The one in the group. And if I may, if you allow me not to spoil some of the messages of our new Capital Markets Day, We will be quantifying the target of CapEx going forward, Which will lead to this free cash flow growth that Jose Maria was highlighting in his speech.

Speaker 11

Fair enough.

Speaker 4

Mathieu, on your free cash flow question, you are right. When you mentioned the EUR 3,300,000,000 That is including spectrum with the estimates that the market may have, which could be around 200, 300,000,000 that's the consensus figures on the spectrum. I cannot disclose any of our own view on that. If we exclude spectrum, consensus is more between 3.6 to EUR 3.7 billion. So that's why we say we are extremely comfortable with that and even we are going forward to EUR 4,000,000,000 Mark, regarding the spectrum that could come, part of it is already flowing because it derives from previous auctions And the main one is Germany that you already know the figures around that.

Speaker 4

Spain already happened, so certainly there and it was a very It was at the reserve price. Uruguay already happened and it's being paid only 25% this year and it was also at reserve price. And then we have some uncertainty about the Ecuador concession renewal because of the political Changes, it may be delayed. And also Argentina, there's the 3.85 gigahertz, But we are not sure if it will be end of this year or maybe a year from now. And in Colombia, we are asking for a very short Period renewal on AWS linked to the agreement we are going to sign with Millicom because we need less spectrum in that scenario.

Speaker 4

And on those that are still pending, I'm not sure that will happen in 2023. I remind you that in Ispan, in general, but you've seen in Ispan, we are being very pragmatical and financial driven 2 spectrums. So that's going to be quite limited as well. But going to the first question, the EUR 4,000,000,000 mark compares with SEK 3,600,000,000 to SEK 3,700,000,000. So we will be out well above The consensus at this moment.

Speaker 11

That's very clear. If I can come back to the question about the sale of copper, if that's materially in any way in terms of The contribution to the group EBITDA?

Speaker 3

Well, the The efficiencies from the copper switch off and the shale mitigate expenditure effort of doing that, It's not significant in the numbers that we have been posting.

Speaker 11

Thank you very much.

Speaker 1

Thank you, Matija. We have time for one last question, please.

Operator

No problem. We will now take the last question from the line of James Ratzer from New Street Research. Please go ahead.

Speaker 8

Yes. Good morning. Thank you very much indeed. So two questions, please. The first one is again just coming back To the €4,000,000,000 free cash flow figure, which undoubtedly is very strong.

Speaker 8

And just looking at the Q2 results, it looks as if your Interest payments are quite low. So my understanding is you're maybe generating now some interest On your cash balances, so I was wondering if you could give us any more guidance on what The interest you're actually now receiving on your cash balances. And also within the EUR 4,000,000,000 Do you assume you might have to pay in Peru on the tax and interest charges? To what extent is that in your EUR 4,000,000,000 And then the second question I had, please, was just regarding the European Recovery Fund. I mean, it's something Vodafone, I think talks a bit more about in Spain than you do, but would just love to hear your thoughts on how you think that could potentially be a positive impact

Speaker 4

Yes. On your question on free cash flow for the remainder of the year and financial payments, the Financial debt related costs that has decreased versus the previous year. It's a combination of the mix of currencies And it's also that we are being, as you said, rewarded for our cash position. We are around Unibor, and that's being part of that. But not only that, I mean, as I said, the fact that we had a very resilient 80% fix Plus the 20% variable has also contributed and this is also the result of our very prudent financing policy and liability management over the years.

Speaker 4

But we are indeed being rewarded for the cash Balances at market prices. With regards to Peru, we had already Some payments included in this first half of the year. And going forward, it could be the case and we are considering that We've seen our outlook of reaching the EUR 4,000,000,000 mark, but There's still a lot of uncertainty around that. We are waiting for the from the tax authorities on the final amount and settlement indications. Some recent rulings are questioning the embedded interest charge in similar proceedings.

Speaker 4

That would be good news for us. So we still need to wait and see. But we are having our own estimate on this. We are also working on different payment alternatives, functioning Payment and all of that is being embedded in our aim to reach that EUR 4,000,000,000 mark. I cannot be more precise on that because it's confidential, it's work in progress and we still have uncertainty around the different

Speaker 3

Regarding the European recovery funds, The non refundable aids for Spain reached EUR 77,000,000,000 to be executed along 5 years With €20,000,000,000 dedicated to digitalization. By the way, the period to execute is 2021 to 2026, so we still have Significant horizon ahead of us. This focuses on three lines: public administration, SME Digitalization [SPEAKER JOSE ANTONIO ALVAREZ PALLETE:] And connectivity and Telefonica is gradually securing a reasonable share of these Funds in public administrations, which could be in this period an opportunity of €5,000,000,000 We are getting Relevant share mainly in central administration projects such as defense and economy ministries projects. In SME Digitalization, Which is an opportunity along this period of around €5,000,000,000 The execution and maybe this is what other competitors are talking about, the execution is a bit low to date. [SPEAKER JOSE ANTONIO ALVAREZ ALVAREZ:] But we're already capturing on the digital grid projects.

Speaker 3

We're capturing part of this opportunity. [SPEAKER JOSE ANTONIO ALVAREZ PALLETE:] The connectivity opportunity, which is around EUR 4,000,000,000 in this period, these are direct subsidies to 1 gs and investments in fiber. In 5 gs, We have already been awarded a significant amount. We are committed to extend the Network deployment across the national territory and then on 5 gs and mobile projects, there have been some limitations Regarding high risk vendors, which are not present in the Telefonica network. So those should be Accessible to us and maybe they are not to some of the competitors that you were alluding to.

Speaker 8

Thank you, Angel. Do you know of the EUR 20,000,000,000 figure you mentioned And therefore, the whole project, how much of that has actually been allocated so far and how much is still to come by 2026?

Speaker 3

Let me see if I have this figure. I don't have that number here, but I'm sure IR will be able to give it to you. Sorry, I don't have this number.

Speaker 8

No problem. But conceptually, it's I might find it's still a relatively low number has been allocated, hasn't it? And there's still more to quite a bit more to come.

Speaker 3

Yes, yes. And in particular, in the SME digitalization, this has been the slowest to execute. There have been awards, but the execution of those awards is flowing slower. On the connectivity side, The awards have been substantial already and in the public administration continues ongoing. So but I would say that more than 50% or Far more than 50% is still to come.

Speaker 8

Thank you. Very helpful.

Operator

Thank you. At this time, no further questions will be taken.

Speaker 2

Thank you very much for your participation, and we certainly hope that we have provided some useful insights for you. Should you still have further questions, we kindly ask you to contact our Investor Relations department. Good morning and thank you.

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Earnings Conference Call
Telefónica Q2 2023
00:00 / 00:00