Koninklijke KPN: A Great Income Pick In The European Telecom Sector (OTCMKTS:KKPNY)

Koninklijke KPN (OTCPK:KKPNY) offers an interesting dividend yield and its valuation is attractive compared to peers, being one of the best income investments in the European telecom sector.

Business Overview

KPN is a Dutch telecommunications company serving both the consumer and business segment customers, offering telephone, internet, and IT solutions. It operates under several brands, including KPN or Glaspoort, and generates all of its revenue from the Netherlands. Its current market value is about $15 billion and trades in the U.S. on the over-the-counter market.

KPN is the leading telecom provider in the Netherlands, having an integrated service offering including fixed and mobile services, fixed and mobile broadband, TV services, and information and communication technology to corporate customers in the Netherlands. More than half of its revenue is generated by the consumer segment, while about one third comes from the business segment, and around 13% from wholesale.

The Dutch telecom market is more concentrated than other European telecom markets, having only three players. As I’ve covered in previous articles, fierce competition is one of the main reasons why many European telecom companies report relatively poor operating trends, especially companies exposed to countries like Spain or Italy, while in the Netherlands higher market concentration provides a better operating backdrop for established players.

In the consumer segment KPN has a market share or about 38%, a level similar to VodafoneZiggo, a joint-venture between Vodafone (VOD) and Liberty Global (LBTYA), while Odido is the third player with a market share of about 23%. In the business segment, KPN is the clear market leader, with a market share of about 63%, while VodafoneZiggo holds 27% of the market and Odido only 10%.

While the Dutch telecom market is mature and growth opportunities are relatively low, KPN has enjoyed some positive trends in recent years supported by its past investments and good network quality, plus its growth strategy has been focused on fiber rollout across the country.

In 2021, it entered into a joint-venture with APG to further accelerate its fiber rollout, in a 50/50 share of risk and return, receiving €440 million from APG in two installments. This JV is expected to invest heavily in fiber over the next few years and be free cash flow positive in five years, when it expects to distribute dividends in a 50/50 share to KPN and APG.

In addition to KPN’s plans to rollout fiber in the Netherlands, this JV allowed the company to more rapidly cover the country and replace its copper network, aiming to reach 75% of Dutch households by 2025, while previously was only targeting 65% of total households.

Indeed, its fiber rollout has been KPN’s major growth driver in recent years, having reached a penetration of 59% of total households at the end of Q1 2024, compared to just 39% at the end of 2020. Its customer mix has naturally changed due to these investments, being nowadays 61% fiber and 39% copper in the broadband segment, a mix that is expected to continue to swing toward fiber over the coming years.

In the mobile segment, KPN has invested in its 5G network and has the best coverage in the country, being also a support for service revenue growth in this segment over the coming years.

Regarding its medium-term targets, KPN intends to grow revenues by expanding its fiber-to-the-home (FTTH) network and decommission the copper network, while from an operating perspective it aims to improve efficiency by reducing complexity and moving more processes to digital channels. From a financial perspective, reflecting that KPN operates in a mature market, its main financial targets imply single-digit revenue and earnings growth between 2024-27, which is not particularly impressive but still better than compared to most European telecom companies.

Financial Overview

Regarding its financial performance, KPN has reported improving operating trends over the past couple of years after some challenging years during the pandemic, supported by its investments in the mobile and fiber networks.

Indeed, its service revenue has recovered to positive growth over the past couple of years, boosted both by mobile and fiber revenues. In 2023, its group service revenue amounted to €2.6 billion, up by 2% YoY, with fiber broadband reporting revenues above €1 billion (+12% YoY) and mobile reached €813 million (+5.4% YoY). On the other hand, its copper revenues declined by 10% YoY to €741 million, as KPN continues to push for growth in the fiber segment and decommissioning its copper network in areas where it already has a good fiber coverage.

In the business segment, KPN reported revenues of €1.8 billion, up by 1.9% YoY, boosted by higher revenues in small and medium enterprises. In wholesale, its revenues amounted to €699 million, an increase of 3.2% from the previous year. Its overall revenues amounted to €5.45 billion in 2023, an annual increase of 2.5%, which is a good outcome compared to its peers.

Despite higher revenues, its EBITDA was almost unchanged during last year, up by only 0.6% YoY to €2.4 billion, due to the inflationary environment that led to higher costs. Its administrative, IT and staff expenses were all up last year, offsetting to some extent its revenue gains. This had a negative impact in its EBITDA margin, which declined by 80 basis points during the year, to 44.4% in 2023.

Nevertheless, this profitability level is much higher than compared to other large European telecom companies, such as Orange (ORAN) or Telefonica (TEF) which have EBITDA margins of around 30%, showing that operating in a concentrated market is key to have pricing power and higher profitability over the long term.

Its net profit amounted to €843 million, up by 10% YoY, benefiting from higher one-off effects, while its operational free cash flow generation was €1.17 billion, representing a decline of 22% from the previous year due to higher spending.

Investors should note that KPN’s cash conversation ratio is quite high because the company has fixed assets with significant depreciation, namely related to its copper network, explaining why its operating free cash flow is significantly above net profit. This operational free cash flow already includes its capital expenditures, which were close to $1.2 billion in 2023, thus it can be seen as cash generated that is available for debt reduction or to distribute to shareholders.

During the first quarter of 2024, KPN maintained a positive operating performance, supported both by its consumer and business segments. In the consumer segment, service revenue increased by 4% YoY to €737 million, boosted by fiber (+13% YoY) and mobile (+7.8% YoY), while copper (-8.2% YoY) continues to report declining revenues as more customer switch to fiber. In the business segment, revenue was up by 1.5% YoY to €458 million, driven by SMEs (+9.9% YoY). Its overall revenues amounted to €1.27 billion, up by 3.6% compared to the same quarter of last year.

Regarding its profitability, KPN was able to report a good cost control and its EBITDA was up by 3.6% YoY to €605 million, a growth rate in-line with its revenue growth, while its net profit declined by 11% YoY to €175 million, mainly due to one-off refinancing costs. Its operating free cash flow was €303 million, an increase of 5.9% YoY.

For the full year, the company increased slightly its guidance, expecting to reach revenue growth of about 3%, EBITDA of €2.5 billion (vs. €2.48 billion previously), and a free cash flow above €890 million (vs. €880 million previously).

Regarding its balance sheet, its net debt amounted to nearly €5.6 billion at the end of last March, which implies a leverage ratio of 2.24x based on its EBITDA guidance for 2024. This is a relatively low leverage ratio compared to other telecom companies, which usually have leverage ratios between 2.5-3x. This means that KPN does not need to retain much earnings in the near future given that its leverage position is comfortable, allowing it to return much of its free cash flow generation to shareholders.

This backdrop has been an important support for KNP’s positive dividend history, considering that it has delivered a growing dividend over the past few years and offers an attractive dividend yield. Its last annual dividend was €0.15 per share, paid in two instalments, an increase of 4.9% from the previous year. On top of dividends, PKN also performed a share buyback of €300 million, which amounts to more than 2% of its current market value.

Going forward, KPN’s guidance is to grow its dividend to €0.17 per share in 2024, representing an annual increase of 13.3%, and grow its dividend by 7% annually during 2024-27. Considering this dividend guidance, KPN currently offers a forward dividend yield of about 4.7%, which is quite attractive for income-oriented investors.

Regarding share buybacks, the company intends to repurchase shares in the amount of around €200 million during 2024, which enhances its total capital return to shareholders. During the period 2024-27, its goal is to perform share buybacks of about €1 billion, which means its current shareholder remuneration policy is expected to be maintained over the next three years.

Regarding its dividend sustainability, KPN’s dividend payout ratio was 71% in 2023, which is an acceptable ratio for a company operating in a mature industry like telecoms, plus its dividend outflows are well covered by free cash flow generation, thus its dividend can be considered to be sustainable and the company’s dividend growth plans appear to be supported by its financial performance. The street also seems to agree given that, according to current analyst’s estimates, its dividend is expected to grow over the next few years, to more than €0.19 per share by 2026.

Regarding its valuation, KPN is currently trading at close to 16x forward earnings, a level that is below its historical average over the past five years of close to 18x, which is a sign that its shares are attractively valued right now. On the other hand, its shares trade at a premium to the European telecom sector, something that seems to be justified by its better growth prospects and higher profitability. Indeed, historically, KPN has traded on average at a premium of 33% to its peers, and its current premium is only 30%, thus KPN seems to offer value for shareholders at its current share price.

Conclusion

KPN is an interesting income pick in the European telecom sector due to its strong fundamentals, supported by its leading position in the Netherlands telecom market. Due to a relatively concentrated market, KPN is able to get rewarded from its investments in 5G and fiber, showing better growth metrics than its peers and a higher profitability level that is sustainable over the long term. Given that its valuation is attractive and KPN offers a high-dividend yield, I see it as one of the best income picks in the European telecom sector nowadays for long-term income investors.

Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.