Telstra (TLS, $3.48)
Market capitalisation: $41.6 billion
Three-year total return: –1.4% a year
FY21 Forecast yield: 4.4%, fully franked (grossed-up, 6.3%)
Analysts’ consensus valuation: $3.73 (Thomson Reuters), $3.805 (FN Arena)
The so-called “NBN headwind” – the forced migration of its customers to the national broadband network, and the loss of revenue from that – is still causing Telstra problems, with the “peak NBN headwind” now expected in FY21 instead of the just-completed FY20. But under the bonnet, things are improving.
Despite a 6.6% slide in underlying earnings before interest, tax, depreciation, and amortisation (EBITDA) to $3.9 billion in the first half of FY20, analysts say that if the NBN headwind effects are excluded, Telstra’s underlying earnings actually rose by about $90 million – the first rise in underlying EBITDA since FY16.
At the height of the COVID-19 market slump in March, the telco heavyweight was one of the few companies able to maintain earnings guidance. Telstra said that FY20 operating earnings were likely to come in at the lower end of the previously stated range, of $7.4 billion–$7.9 billion, with free cash flow expected at the lower end of the $2.9 billion–$3.3 billion range (it definitely helps to give a range for guidance!)
However, if you were minded to consider the pinning of the guidance to the lower end of the range as effectively a downgrade, what was causing it was the virtual removal of mobile roaming revenue – because no-one was travelling anymore – as well as the extra data that Telstra offered to family and small business customers to handle remote business and education (and the extra streaming service to help people cope with lockdown!) In addition, Telstra has had to hire temporary personnel and pause its program of job reductions.
In fact, not only has Telstra frozen its headcount cull, having been forced to temporarily close its call centre operations in the Philippines and India on the back of the COVID-19 outbreak, the company has hired 3,500 extra staff to fortify its Australian centres. Telstra now says it will keep its inbound call centres in Australia even after the coronavirus pandemic subsides, with all inbound calls to be answered locally by the end of FY22.
On the share market, Telstra was going well before the pandemic emerged. Starting the year at $3.54, Telstra moved to $3.90 in February before COVID took the share price back below $3, a fall of 23%.
Since then the stock has moved back to $3.50, up 17% from its low point.
Telstra has to spend to grow. The company has brought forward $500 million worth of capital spending from 2021 into this year and will spend a similar amount to increase the capacity in its network, including its 5G rollout. At present, Telstra’s 5G service now covers parts of 47 cities, ahead of its original target of 35 by end-June, with more than 8 million Australians in the coverage area. Telstra is on track to be the first telco to enable standalone, end-to-end 5G across Australia. The company says 5G will be ten times faster than existing 4G networks. The government sees acceleration of the digital economy as crucial to the recovery of the overall economy – Telstra’s 5G looks like a product coming into its own at exactly the right time.
The company’s corporate reorganisation is also impressive, with a group of companies it has acquired in recent years now brought together into a brand called Telstra Purple, which the company says is now Australia’s largest technology services business. Meanwhile, the “value brand”, Belong – a mobile virtual network operator (MVNO), uses the Telstra wholesale mobile network to offer internet and mobile services and is proving highly competitive. Telstra has realised that if it is going to be undercut on price, it may as well be itself that’s doing it.
The half-year result showed that the price sensitive Belong package was bringing customers into the mothership. Investors will be looking closely to the FY20 result to see if this growth accelerated in the second half. It will need to do so, to counteract customer losses from the Foxtel from Telstra product.
Ultimately, though, it will be 5G and the services that Telstra packages around it that drives revenue and earnings growth going forward, over the NBN headwind peak.
In earnings per share (EPS) terms, the analysts’ consensus at Thomson Reuters expects 22% earnings growth for FY20, to 22.1 cents a share, the first year of EPS growth since FY16. That is from a sample of 13 analysts.
On FNArena’s collation (a sample of six analysts), Telstra’s EPS is expected to fall, by 5.7%, to 17.1 cents, and slide further, to 16.2 cents, in FY21.
What many investors mostly want to know about Telstra is the security of the dividend. FNArena sees the all-important dividend per share (DPS) staying at 16 cents in Telstra’s FY20 result but cut to 15.5 cents in FY21. Thomson Reuters also expects a 16-cent dividend for FY20.
Investors should have been cured, however, of any blind faith in Telstra’s dividends.
For a long time – 2005 to 2013 – it was 28 cents a year, expected. This rose to 29.5 cents in FY14, and to 30.5 cents in FY15. FY16 and FY17 both saw 31 cents paid, and for many, that became the new expectation. But Telstra encountered market conditions in which mobile competition had increased significantly and the company’s mobile margins could not be sustained. The dividend payment in FY18 was 22 cents and in FY19 that was cut to 16 cents, in a combination of ordinary and special dividends.
Between February 2015 to June 2018, Telstra’s share price slid from $6.50 to $2.62. If ever yield-oriented investors needed a reminder of the capital risk that is incurred when relying on stocks for yield, that was it.
Those Telstra investors now relying on 16 cents as their line-in-the-sand for yield have already received 8 cents.
The consensus among analysts is that the company’s free cash flow appears capable of sustaining a dividend payment at the 16-cents rate for FY20, but it does get harder from here. UBS, for example, sees a dividend of 14 cents in FY21 – but with scope for Telstra to maintain 16 cents out to FY23, if increased mobile earnings or a change in dividend payout policy (currently a payout ratio of 70%– 90% of net profit) allow it.
At the current dividend expectation of 16 cents for the just-completed FY20, Telstra, at $3.48, is trading on a 4.6% fully franked yield, equivalent to a grossed-up yield of 6.6%. If we stress-test that to 15.5 cents in FY21, the forward yield becomes 4.4%, or 6.4% grossed-up. Using UBS’ worst case of a 14-cent dividend, the forward yield becomes 4% – or 5.7% grossed-up. People who bought TLS above $3.48 will earn a lower yield than that and people who bought for lower than $3.48 will earn a higher yield.
With the capital growth foreseen in analysts’ consensus price targets – all investors should take a total-return approach to shares – you can definitely make a case for buying TLS at these levels.
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