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Readers may find my previous coverage via this link. My previous rating was a buy, as I believed Orange S.A. (NYSE:ORAN) would see a positive trend in its stock price as the market focused on its improvement in FCF profile. Also, valuation at 10x EV/forward EBITDA was not too demanding.
I am reiterating my buy rating as ORAN is still attractive at this share price. 1H23 performance was strong, and management is confident that 2H23 performance will be just as strong as 1H23, albeit feeling the full impact of the recent price increase. While this might cause some near-term volatility as the market adjusts its expectations through the quarters, my long-term DCF model suggests that ORAN just needs to be able to sustain 5% EPS growth for us to see attractive upside.
Financials/Valuation
The results for 2Q23 were €10.93 billion in revenue, which is 1.1% higher than the consensus estimate of €10.81 billion and indicates organic growth of 2.6%. Enterprise, IC&SS, A&ME, Poland, and Spain all contributed significantly to the revenue beat. But the €3.3 billion in EBITDAaL was in line with expectations, suggesting 1% organic growth y/y and margins of 30.2%.
With two consecutive quarters of price increases, France was able to cut its year-over-year revenue decline in half in 2Q23. In addition, churn decreased to 11% from 12% in 1Q23 which was a direct result of the announced price increased at the beginning of the year. As energy tailwinds weaken and ORAN reaps the full benefit of price increases, I anticipate this revenue decline will gradually improve over the next few quarters, and eventually turn positive.
In Spain, however, things were looking up. The double price increase that ORAN received in August 2022 and March 2023 was the primary factor in the company’s 2.1% revenue growth and 115% EBITDA growth. Since it has already lapped the easy competition, I anticipate growth to slow considerably in 2H23. Contrary to expectations, management believes that growth in 2H23 will be comparable to growth in 1H23. This could mean that management plans to raise prices again, or that the underlying volume trend is strong as of the beginning of July. Regardless, I plan to keep my cautious stance while keeping my fingers crossed for a pleasant surprise.
Finally, African and Middle Eastern growth continues to fuel the Group, contributing 12% to both revenue and EBITDA growth.
Based on my view of the business, ORAN should be able to grow EPS at 5% a year for the growth stage of my DCF model. This 5% is supported by low-single-digit revenue growth, driven by a mix of price and volume. The low-single-digit revenue growth should translate to margin expansion over time, driven by both operating and financial leverage. This 5% is also in line with ORAN’s historical EPS growth rate since 2014 (from EUR0.54 in 2014 to EUR0.90 in the LTM). Based on my expected return rate of 10%, I have a price target of EUR15. While this upside seems a lot today (50%), I refer readers to the 5-year stock chart, where EUR15 is basically where ORAN traded at pre-covid.
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Comments
Overall, the results showed strong but peaking recovery in Spain and steady growth in Africa, while also showing improving but ongoing declines in France. The full impact of the recent price increase will be seen by management in 2H23, which will be the catalyst for further positive rerating in the coming quarters if growth is as strong as expected. If it does, then I think consensus will start to revise their estimates to incorporate the underlying strength. If 3Q23 came in weak, I think the stock will see some near-term pressure and possibly a risk-off situation as investors look to 4Q23 to see if growth will be as strong as expected.
Risk & Conclusion
While I am confident ORAN can grow 5% EPS for the long run, the risk is that ORAN will miss near-term estimates as management might be overconfident that 2H23 performance will be just like 1H23. This could trigger a string of negative sentiments, pressuring the stock until either ORAN resets expectations by revising their “guide” or the business shows an inflection in growth. All in all, I maintain my buy position on ORAN based on its strong 2Q23 performance. That said, while 2Q23 results exceeded expectations, the focus is now on 2H23 performance. The market may experience near-term volatility as it adjusts its expectations, but my long-term DCF model suggests attractive upside if ORAN sustains 5% EPS growth. Key factors include sustained low-single-digit revenue growth driven by price and volume, margin expansion, and growth in Africa and the Middle East. However, there are risks, such as management’s confidence in 2H23 performance potentially leading to missed near-term estimates. This could trigger negative sentiments, putting pressure on the stock.
