Cellnex Telecom: Upside Potential As Interest Rates Decrease (OTCMKTS:CLNXF)

Introduction

It’s not a secret I like infrastructure ideas, and mainly the type of infrastructure that plays a pivotal role in society, ideally with high barriers of entry. The cell phone tower business is one of those types I really do like and Cellnex Telecom (OTCPK:CLNXF) (OTCPK:CLLNY) is Europe’s largest phone tower owner with almost 140,000 cell phone towers. Cellnex was a market’s darling during the era of low interest rates but its share price has been under pressure in the past few years due to the changing interest rate environment.

That being said, I have become increasingly bullish on Cellnex for two reasons. First of all, I think interest rates in the financial markets have peaked. And secondly, Cellnex recently changed its approach and is now becoming more shareholder friendly. Until now, the company used all incoming cash flow to reinvest in the business, but it’s now dangling a dividend carrot in front of its shareholders. The combination of these elements will make the stock more appealing.

Cellnex Telecom is a Spanish company and its primary listing on the Madrid Stock Exchange where it is trading with CLNX as its ticker symbol for sure is the most liquid listing. The average daily volume is 1.5 million shares and the current market capitalization is just over 25B EUR based on the current share count of approximately 705.5M shares.

A satisfying result in the first half of 2024

Cellnex only provides detailed financial results every semester so I’m always looking forward to see the semi-annual reports.

In the first half of this year, Cellnex reported total revenue of 2.12B EUR, an increase of almost 6% compared to the first half of last year. Additionally, the staff costs decreased by almost 10% although this was countered by a 7% increase of the other operating expenses.

As the income statement above shows, Cellnex reported an operating loss of almost 137M EUR in H1 2024 compared to a 139M EUR operating profit in H1 2023. This difference is clearly caused by the 402M EUR impairment charge recorded in the first half of the current financial year. Excluding that impairment charge, the operating profit would have almost doubled on a year-over-year basis, and have increased by almost 50% if I would also filter out the gain on the disposal of assets.

The net finance expenses remain high and increased further to a net amount of about 309M EUR compared to just 238M EUR in the first half of last year. The total interest expenses on lease liabilities did decrease, but this didn’t really have a major impact in the greater scheme of things.

The net loss of 418M EUR represented an EPS of -0.59 EUR per share, but as explained in my previous coverage on Cellnex, this is a free cash flow story and not necessarily an earnings story. After all building a new cell phone tower mainly represents a significant upfront cost, but requires very low maintenance capex. And that means the free cash flow (on a sustaining basis) is usually substantially higher than the reported net income.

The image below shows the operating cash flow calculation. As you can see, the reported operating cash flow was approximately 1.11B EUR, and roughly 1.12B EUR after adding back the changes in the working capital position.

We should also deduct the 11M EUR in dividends to non-controlling interests as well as the 388M EUR in lease payments and that results in an adjusted operating cash flow of approximately 721M EUR and close to 760M EUR if you’d exclude the provisions related to employee benefits.

The image above shows total capex was 1.08B EUR in the first semester. However, it’s important to make the distinction between maintenance capex and growth capex. And as the image below shows, the maintenance capex was just 37M EUR, resulting in an underlying free cash flow result of around 720M EUR.

My calculation includes some non-recurring items. If you’d strictly follow how the company calculates the recurring levered free cash flow result, you’d end up with 781M EUR using the EBITDA as starting point and after deducting the lease payments, interest payments, taxes and sustaining capex, while keeping all other elements included in the equation.

As far as I am concerned, the company remains on track to meet its mid-term objectives

The robust result in the first half of the year also means Cellnex is reiterating its guidance for this year. As you can see below, it aims to achieve adjusted EBITDA of around 3.2B EUR (on a midpoint basis) while the recurring leveraged free cash flow result should be around 1.7B EUR (again on a midpoint basis). But as Cellnex continues to invest in growth, the reported free cash flow will be just a few hundred million Euro.

I have a relatively long-term view on this company, and although the 2024 guidance looks pretty decent, I’m mainly interested in the company’s plans and ability to grow the recurring free cash flow and the reported free cash flow in the next few years. The image above shows Cellnex aims to generate in excess of 2B EUR in recurring free cash flow in 2025 while the total free cash flow result including growth should increase by 30%-40% as well compared to this year. And looking further ahead, by 2027 the RLFCF should stabilize at around 2.2B EUR per year but more importantly, the growth capex will decrease which means the company anticipates in excess of 1.1B EUR in net free cash flow to hit the balance sheet.

Investment thesis

Divided over the 705.5M shares outstanding (including the impact of treasury shares), the RLFCF in 2027 is expected to come in at just over 3.1 EUR per share. This represents a free cash flow yield of around 9% after the recent share price increase, but if the benchmark interest rates continue to decrease, there’s no reason why Cellnex couldn’t and shouldn’t be trading at a sustaining free cash flow yield of 6-6.5% (if for instance the five-year yield on government bonds drops toward 2%, this would still represent a markup of 400-450 bps). Applying a required yield of 6.5% on the anticipated 3.10 EUR in recurring free cash flow would indicate a fair value of around 48 EUR per share.

Given the increasing cash flow profile and the increasing attention toward shareholder distributions while maintaining its investment grade status make Cellnex appealing. I have a small long position and I have written about half a dozen put options. Unfortunately all of them are currently out of the money so I will have to continue to sell put options in the near future.

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.