At the Telstra AGM last week, Telstra Chairman John Mullen removed one of the major uncertainties hanging over the stock and effectively committed to maintaining the dividend at 16 cents per share. But does this make Telstra a buy?
Firstly, the background to the dividend story.
Telstra’s current policy is to pay a dividend comprising two components – an ordinary dividend from underlying earnings with a target range of 70% to 90%, and a special dividend from the net ‘one-off’ payments from the NBN. The latter are made as customers migrate from the Telstra backbone to the NBN, and are now declining as the rollout comes to an end.
In FY20, the ordinary dividend was 10c per share (5c for each of the interim and final dividends). The special dividend was 6c per share (3c for each half), which represented 66% of the net one-off NBN payments, in line with Telstra’s guidance to return around 65% to shareholders.
But for FY21, net NBN one-off payments are forecast to decline from the $1.5bn in FY20 to $0.7bn to $1.0bn, and they will decline again to almost nothing in FY22.
At the AGM, Mullen said:
“the Board clearly understands the importance of the dividend and if necessary is prepared to temporarily exceed our capital management framework principle of paying an ordinary dividend of 70% to 90% of underlying earnings to maintain a 16c dividend”.
Telstra has previously said that to maintain the dividend at 16c post the NBN, it needs to achieve underlying EBITDA in the order of $7.5bn to $8.5bn. In FY20, it earned $7.4bn and for FY21, it has guided to EBITDA of $6.5bn to $7.0bn (due to Covid-19 costs of $400m, up from $200m in FY20, and NBN headwinds of around $0.7bn).
Mullen alluded to a softening on this position, saying that the factors the Board would consider include:
- whether an underlying EBITDA of $7.5bn to $8.5bn post the rollout of the NBN is achievable.
- whether the free cash flow dividend payout ratio remains supportive and we retain a strong capital position; and
- whether there are other factors that would make the payment of the dividend at that level imprudent.
This doesn’t absolutely guarantee that the dividend will be 16c per share, and we have seen Board Chair make horrendous calls before (recall Jac Nasser from BHP with his ‘progressive dividend’ commitment), but we can with reasonable confidence expect 16c in FY21 and in all likelihood again in FY22. UBS raised its forecast as a result from 14c to 16c, and looking ahead to FY23, says that it can see Telstra with free cash flow of more than 23c per share, which should support a dividend of 16c per share.
Now, is Telstra a buy? Here are 5 reasons.
5 reasons to buy
Firstly, with a dividend of 16c per share, this implies a fully franked dividend yield of 5.6% (based on a share price of $2.84). This is equivalent to a grossed up yield of 8%. There will be support from income-oriented investors at these prices, helping to put a base under the share price.
Next, Telstra should get a boost from the imminent launch of Apple’s new 5G phones, the iPhone 12. With the biggest 5G enabled network, Telstra is well positioned to capitalise from the excitement this should generate. The challenge for Telstra will be to translate this opportunity into higher per customer revenue plans.
Third, the major brokers are bullish on the stock. According to FNArena, the consensus target price is $3.44, 21% higher than Friday’s close. Recommendations and target prices from the major brokers are shown below.
Source: FNArena
Fourthly, the spin-off/sale/demerger of the infrastructure company (Telstra InfaCo) could be particularly accretive for shareholders.
Quoting the Chairman:
“We will now be able to provide transparency over the different asset classes in our infrastructure business, and from the end of this financial year be ready to consider monetizing some or all of these assets if this creates appropriate value for shareholders. In the event of any eventual privatisation of the nbn, this may include the opportunity for Telstra to work with government on solutions for the nbn.”
Finally, since listing on the ASX in 1997, there has been considerable support for Telstra when its share price has been under $3. I am no technician, but the graph below (which covers the last 10 years) shows how it has bounced off this level.
Telstra – 2010 to 2020
Source: nabtrade
And two reasons not to buy
Firstly, it’s Telstra.
Secondly, Telstra still faces enormous revenue pressures. In the year to 30 June 2020, total income fell by 5.9% to $26.2bn. For the next financial year, Telstra has guided to income in the range of $23.2bn to $25.1bn. Competitive pressures, plus the impact of the nbn headwinds, do not seem to be abating.
Potentially, the recent decision by the Government to spend an additional $3.5bn on upgrading the nbn to give access to ultra-fast broadband could hinder Telstra’s options to grow.
Here’s my call
I will stick my neck out and say that Telstra is in the buy zone.
I think the risk on the downside is limited, and that’s primarily what makes it a buy.
I also do not think it is going to “run-away” on the upside, so if capital gain is your main motive, there are other stocks to consider. Investors can be patient.
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