MARKETS SPECTATOR: Citi's Telstra warning

What cost to Telstra and its share price? That is the question following reports of breaches of asbestos safety procedures by contractors working on the national broadband network for Australia’s dominant telecommunications company.

Citigroup analyst Elaine Prior says Telstra’s announcement that 200 specialist workers will inspect and supervise asbestos related work may add $30 million a year in extra labour costs to the company. That is a 0.2 per cent increase in Telstra’s cost base, she says.

“Under the ‘Provide or Pay’ provision of the contract with NBN Co, in relation to infrastructure made available for fibre construction, it appears possible that asbestos challenges might reduce the amount of infrastructure Telstra can provide to NBN Co,” says Prior. 

“This represents a material cost risk, should Telstra be required to replace some of the pits and ducts deemed not suitable. The magnitude of this risk is difficult to quantify at present.

“While Telstra advised us that the presence of asbestos was factored into project cost and timing, it would be interesting to know whether contractors bidding on the remediation project fully understood the scale of the problem,” the Citi analyst adds.

Amid public health and safety concerns, additional asbestos precautions may impact the NBN rollout, resulting in higher construction costs augmented by delays.

“For Telstra, a delay to the NBN rollout schedule represents a potential risk to forecasts and valuation,” says Prior.

“A delay to rollout would push back the timing of forecast cash receipts from NBN Co under the disconnection payments and infrastructure leasing.” 

Citi’s dividend discount model valuation on Telstra, including the delayed rollout, is $4.50 per share. 

“We believe the risk of the government ceasing the construction of the NBN project, due to perceived unmanageable risks around asbestos, is unlikely given the asbestos risks were covered in the planning of the network construction,” says Prior.

In the event the NBN project shutdown, Prior’s dividend discount valuation of Telstra, without the cash payments from NBN Co, is $4.02 per share.

Since its 52-week high of $5.15 on May 22, Telstra’s stock has dropped 9.9 per cent. The S&P/ASX200 index has declined 6.5 per cent during the same period.

At 1124 AEST Telstra shares were down 4 cents, or 0.9 per cent, to $4.63 against a benchmark S&P/ASX200 index fall of 1.4 per cent.