Time to get Telstra before everybody else does

Chief Investment Officer and founder of Aitken Investment Management
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This week I attended a drinks function with the vast bulk of Telstra’s senior management team, ahead of Telstra’s investor day.

Part of my job is reading body language of company executives. If I am any good at that, I can sense a growing confidence in the Telstra camp.

This is the complete reversal from three years ago, when any time you met a Telstra executive they were on the defensive.

Sentiment booster

To me this change is very important. The greatest returns you make are from companies with an internal confidence, not an arrogance, but a confidence. When that confidence meets a consistent strategy, you generate market-beating returns.

I just get the feeling the Telstra executive team has worked out that Telstra is holding all the cards in the sector (see Barrie Dunstan’s Monday column for his view on Telstra as the best media play). As I have written before, mobile data growth is through the roof as we transform to a digital economy, and the Australian economy simply can’t open for business each day without Telstra’s networks.

I see Telstra as the “railroad” and the technology-based companies as the “carriages” on the railway. Interestingly though, the market currently pays a massive P/E premium for the “carriages” over the “railroad”. It is like the old fable of the hare and the tortoise, but just remember who ends up winning that race.

Growth plus yield

Telstra is actually a growth stock, with a rising and high sustainable dividend yield. While most investors have bought it for its high and reliable fully franked dividend stream, what they didn’t realise, is they actually bought a growth stock. Telstra this year will generate back-to-back years of double-digit EPS growth. It is a clear GDP plus growth stock, as top line growth translates to even stronger bottom line growth.

This is an extremely important point. If I am to be proven right and Telstra raises the FY14 annual dividend from 28 cents fully-franked to 30 cents fully-franked, for that to happen I suspect the Telstra board has to be very comfortable with EPS cover for the DPS and the sustainability of that EPS growth.

FY14 consensus EPS estimates continue to be revised up, but in my opinion, they remain too conservative. As you can see below, consensus jumped after the FY13 result, once analysts released they had underestimated the translation from top line growth to bottom line growth. The circled area below focuses on that area.

TLS: consensus FY14 EPS

To me this suggests the financial models analysts are using for Telstra are simply out of date. They aren’t correctly modeling the translation to EPS growth, and in reality EPS growth is what matters from this stock. Telstra doesn’t guide EPS and that, in itself, is interesting.

Similarly, FY14 free cash flow for Telstra continues to be revised up, meaning the potential dividend rise in FY14 is very well covered by cash. Interestingly though, the consensus free cash flow estimate is below the low end of Telstra’s guidance range. Again, I think that is clearly too conservative.

TLS: free cash flow FY14

Consensus forecasts lack courage

To me, that’s why consensus recommendations and price targets on Telstra remain so timid, as they have for the past two years in this Telstra upgrade cycle.

The BUY/HOLD/SELL ratio in TLS is 4/10/5. The median 12-month price target is $4.91 as illustrated below. Note very well the 2-year trend of analyst price targets CHASING the TLS share price. This is clearly set to continue.
You see, I love the fact there is still consensus analyst skepticism towards Telstra. That is an essential element in the path to $6.00.

We are blatantly entering a digital age. In fact, there is clear evidence of tech boom 2 starting, as investors put huge multiples on potential game changing new technologies. To my way of thinking, that is a massive macro tailwind for Telstra in terms of both the volumes of data they carry and the prices they charge for it. This will be occurring as they continue to strip out legacy costs.

Telstra is going to be allocated a higher P/E by the market as it comes around to realising this growth potential. It is also going to be simultaneously adding P/E for the strategic value of its industry leading networks, its growing market share (with lower churn) and earnings growth/dividend growth.

The forecasts

For FY14 I forecast Telstra to generate EPS of 33.7 cents, up from 30.7 cents in FY13. Yes, back-to-back years of 10% EPS Growth from Telstra. On the basis of EPS being 33.7 cents, I expect the Telstra board to lift the FY14 annual dividend from 28 cents fully-franked to 30 cents fully franked. That would maintain a 90% payout ratio.

On my forecasts at $5.03, Telstra is trading on 14.9 times FY14 earnings and a prospective FY14 dividend yield of 5.95% fully franked. EPS growth is forecast at 10%.

My 12-month price target on TLS of $6.00 would see TLS trading 17.8 times FY14 delivered EPS, and a 5.00% fully franked delivered FY14 yield.

As you all know, I’ve been on this positive Telstra bandwagon for many years. The stock is now 4.75% of the benchmark ASX200 Index. After chatting with the management team, and running the financial models for the years ahead, I can say I have never had higher conviction in Telstra as a company or as a total return investment.

The last three years were the hard part of the Telstra investment case, the next three years will be much easier.

TLS is taking out 16-year technical resistance @$5.00

TLS remains a core member of our high conviction buy list, and a key part of the market heading to 6,000.

See you all @6,000

Go Australia, Charlie

Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.

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