- Telstra has updated investors on its Sensis strategy - Focus is on new revenue streams in SME market - Competition and high cost base remain issues

By Chris Shaw

Sensis, the advertising and directories arm of Telstra ((TLS)), represents about 9% of group revenues and 17% of earnings before interest and tax. This makes the division an important part of Telstra's overall business.

The division briefed the market yesterday on a revised strategy for growth. The update highlighted an investment in systems and multi-platform products designed to reduce customer churn levels.

As RBS Australia points out, this investment is to help target SMEs (small to medium-sized enterprises) in an attempt to generate new revenue streams (online instead of print). The strategy is aimed at offsetting a decline on the print side of the directory operations.

Credit Suisse sees the approach as an attempt to create a one-stop advertising solution for SMEs, the expectation being enhanced online capabilities should translate into better lead generation for advertisers.

An extensive sales force is seen as an advantage in this regard, as are strong existing relationships with customers. Credit Suisse views the strategy as having merit, especially given only around 17% of SMEs have a digital advertising strategy.

One issue for Credit Suisse is Sensis will need to compete in the online space with the headwind of a higher cost base. This creates difficulties as a move to online operations generally means an erosion in revenues.

BA Merrill Lynch also makes this point, as while it too saw some positives in the new strategy for Sensis, the lack of any cost-out options is expected to prove an issue. The other issue for BA-ML is revenue targets from new customer growth, which are seen as challenging.

This is particularly the case as a price optimisation program conducted by Telstra in FY08 and FY09 may mean some potential customers choose not to return to the service.

Morgan Stanley takes the view what didn't work in print is unlikely to work in the digital market as the strategy essentially remains one of cross-selling where possible. This is in a more competitive market, where the likes of Google continue to make inroads in directories offerings.

Post the briefing, Morgan Stanley has moved its bear case assumptions of 15% annual revenue declines and a reduction of long-term margins from 50% to 30% to its base case expectation.

In contrast, Telstra's briefing suggested a mid single-digit decline in sales and a high single-digit decline in EBITDA (earnings before interest, tax, depreciation and amortisation) in FY11. Similar trends are forecast for FY12 and FY13, before a return to organic revenue growth in three years. Both UBS and Goldman Sachs sit below these numbers with their respective forecasts (as does, of course, Morgan Stanley).

While Sensis continues to face problems, UBS suggests for Telstra overall an earnings rebound in FY12 remains likely. This reflects the benefits of Project New and improving subscriber momentum.

As well, UBS notes the sell-down of part of its Telstra stake by the Future Fund will reduce the overhang in the stock and increase Telstra's weight in Australian indices. Add in more definite NBN agreements in coming months and UBS continues to see value in Telstra shares at current levels.

The market appears to agree, as the FNArena database shows six Buy ratings for Telstra against one Hold recommendation and one Underperform, this courtesy of BA-ML. Goldman Sachs is not in the database but rates Telstra as a Hold, while Morgan Stanley has a Buy rating within an In-Line view on the Australian telco sector.

The consensus price target for Telstra according to the FNArena database stands at $3.22, which implies upside of around 16% from current levels. Goldman Sachs has a target of $3.08, while Morgan Stanley's price target is $3.20.

The price target is based on consensus earnings per share forecasts of 24.9c in FY11 and 26.8c in FY12. These forecasts are essentially unchanged post the briefing.

Shares in Telstra today are stronger and as at 11.35am the stock was up 5c at $2.81. Over the past year Telstra shares have traded in a range of $2.55 to $3.46.

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