Despite Sprint’s Recent Operational Improvements, Significant Risks Remain

We have increased our price estimate for Sprint (NYSE:S) from about $5 per share to about $6 per share, which is still slightly below the current market price, on account of the carrier’s expanding postpaid subscriber base and its progress in cutting operating costs. However, Sprint’s sizable (and growing) financial leverage as well as the risks stemming from its ongoing network expansion plan remain key concerns.

See Our complete analysis for Sprint

Improving Postpaid Metrics And Expanding Margins Are Encouraging

The first and most important part of Sprint’s turnaround plan has been to bolster its  postpaid subscriber base, and the carrier has executed fairly well in this regard, on account of aggressive promotional offers as well as its gradually improving network quality. Sprint added a net of 195k postpaid phone customers during the first half of 2016, compared to net losses over the same period last year. Sprint also stands to gain the most from the launch of the iPhone 7. While nationwide U.S. carriers have been offering the device for free with trade-in promos, Sprint will only offer the promotion with its leasing scheme, rather than via equipment installment plans (EIP), reducing its loss per sign-on by as much as half compared to its bigger rivals (related: Why Sprint stands to gain the most from iPhone 7). This also allows the carrier to offer its promos for an extended period of time (most rivals have ended their promos), winning over more customers.

Sprint has also been expanding its EBITDA margins in recent quarters (up by about 500 bps year-over-year to 31% during Q1 FY’16). While this is partly due to the shift towards handset leasing, which pushes costs to the depreciation header, the carrier has also been cutting down on its network and SG&A expenses (down by about 12% each, during Q1 FY’16). It’s likely that Sprint’s margins will continue to expand going forward, as its revenue base increases, amid recent postpaid subscriber growth and also as it looks to achieve a sustainable reduction of $2 billion (roughly 10% of total OpEx) or more in run-rate operating expenses exiting this fiscal year.

High Leverage And Lower Network Spending Remain Key Concerns

Although the recent operational improvements are encouraging, the carrier does face significant risks. Sprint’s debt load stood at $37 billion as of June 30, and the number has been trending upwards in recent years (it stood at $32.5 billion in June 2014 and $34 billion in 2015). About $3.3 billion is due later this fiscal year, and average annual maturities over the next seven years stand at roughly $3 billion. While Sprint has been talking up its total liquidity position of roughly $11 billion, the sources of liquidity are a mixed bag. The carrier has grown its cash and cash equivalents to about $5 billion, leveraging its handset leasing and network equipment vehicles, with another $5 billion+ coming from unsecured financing facilities and revolving bank credit. Ultimately, the carrier will have to turn profitable and generate positive free cash flows in order to reduce its debt load. However, returning to net profitability may prove difficult in the near term, given its increasing interest expenses (up 13% y-o-y in Q1 FY’16).

It also remains to be seen how well Sprint is able to support its growing subscriber base and rising data traffic, as it defers network spending (projected cash capex is down to $3 billion vs. $4.6 billion last year as it looks to conserve cash). In comparison, T-Mobile, which is only slightly ahead of Sprint in terms of total subscribers, projects 2016 capex that is at least 50% higher. Sprint is trying to make the most of its reduced capital budget by taking a relatively unproven (and potentially risky) route to densifying and expanding its network (related Is Sprint Making A Mistake Bowing Out Of The 600 MHz Spectrum Auction?). As Sprint is no stranger to network issues (a botched network upgrade carried out several years ago is partly responsible for its current situation), the current network expansion will be a key factor to watch in the interim.

View Interactive Institutional Research (Powered by Trefis):

Global Large Cap | U.S. Mid & Small Cap | European Large & Mid Cap

More Trefis Research