Forsyth Barr upgrades Chorus in wake of review

Forsyth Barr has upgraded its recommendation on Chorus shares to accumulate following the release at the weekend of the Ernst and Young (EY) review on cash-saving initiatives for the infrastructure company.

The EY review reported a potential funding shortfall of up to $250 million in meeting the commitment to the Government's ultra-fast broadband (UFB) and rural broadband initiative (RBI).

Forsyth Barr broker Suzanne Kinnaird said the shortfall identification was expected.

The shares rose yesterday to $1.53 after the review's release as investors started to understand more about the problems.

Chorus earlier identified a shortfall close to $1 billion following the Commerce Commission ruling a cut to wholesale internet pricing through the company's copper line network.

Ms Kinnaird said Chorus' current share price reflected regulatory risks and uncertainty over the cost-based reviews and the final costs of the UFB programme.

''There is potentially long-term value in owning both the legacy copper network and what will be the largest fibre network in New Zealand.''

There was also potential in the event of relatively small increases in copper prices as a result of the cost-based review of access to the network.

''We recognise there is significant short-term uncertainty around Chorus until copper pricing is resolved.

Accordingly, we apply a market discount over the next 12 months to our long-term valuation to allow for this,'' she said.

Forsyth Barr has a $1.90 target for Chorus shares.

Ms Kinnaird said the EY report assumed dividends from Chorus would stop until the second half of the 2016 financial year, resuming at 12.5c per share.

Chorus was expected to achieve cost savings of $400 million to $450 million from 2015-20 - around $70 million a year.

The EY review suggested no benefits were likely from discussions between Chorus and Crown Fibre Holdings and no change in copper pricing from the cost-based reviews.

Ms Kinnaird said it was important to remember the review was an independent report and, while influenced by Chorus, did not represent actual decisions made by the company.

''The cost out target appears aggressive given Chorus has already assumed UFB-related costs per connection or house passed will fall significantly over this same time period.

"However, the shortfall will be offset by a relatively small increase in copper charges which are being reset under the cost-based reviews.''

The most important aspect of the review was it highlighted some of the actions Chorus would need to consider to reduce its costs.

They included:

• Reducing discretionary investment in copper services, leading to gradual deterioration in services;

• Delays in new connections;

• Full upfront recovery of any non-UFB or RBI connection costs.

Chorus would provide telecommunications access infrastructure to most of New Zealand for the next generation but its valuation during the next 12 months would be hampered by regulatory uncertainty, Ms Kinnaird said.

''We consider there is potentially an attractive long-term investment case but uncertainty will prevail in the short-term.''

Chorus chief executive Mark Ratcliffe said in a statement the EY review aligned with the company's market disclosure on November 5 and information provided to shareholders last week.

Revenue, cost and investment-related initiatives identified would be weighed carefully.

''While they may save money that can then be invested into UFB, they also have the potential to negatively impact service levels and broadband services for consumers across New Zealand on the current network.''

The right balance must be struck to ensure consumers continue to benefit from high quality infrastructure, he said.

EY had provided a high-level view on some potential capital management scenarios but Mr Ratcliffe's view was the true cost and viability of those options was incomplete.

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