Clearly, the volatility I predicted has arrived somewhat dramatically in global and local equity markets. Everything happens very fast nowadays and I need to react to developments at pace as prices move so quickly.

In periods like this, it is best to go back to what you know best. What you feel most certain about. No doubt this volatility may persist, so I want to be rock solid in the stocks I own in portfolios.

I must stress to you the trick from here is NOT TO GET MORE BEARISH AS PRICES FALL/VOLATILITY SPIKES. It is just a long-overdue correction, not a crash.

We should have been prepared for this and must now look to take advantage of these better risk adjusted prices and higher dividend yields in the right stocks.

Telstra back in the good books

I am upgrading Telstra (TLS) back to “buy” after downgrading it to “hold” back on 15 August 2014.

Telstra has pulled back from a cum dividend peak of $5.76 and is now ex the 15 cent fully franked final dividend and the off-market buyback entitlement. The carry trade unwind capital loss, outside the value of the dividend, franking credits and buyback entitlement, is equal to one year’s annual Telstra dividend yield. On that basis, I think Telstra is now risk-adjusted value and likely to be supported at these levels by prospective dividend yield alone.

Telstra also got through its AGM this week with no damage, in fact I think the AGM was positive and confirmed Telstra remains right on strategic track. This is one of the key attractions of Telstra: they are now corporately predictable and consistently “on message”.

To quote the Oracle of Omaha “a monopoly toll bridge is my dream investment”. Due to its scale, reach, coverage and network advantage in Australia, in the TMT sector Telstra is effectively a “monopoly toll bridge”. Its competitors are significantly weaker in every aspect of the telecommunications business and, in my view, Telstra is expanding its dominance of its competitors, led by service and most importantly, reliability of mobile service.

This is in a period of structural increase in demand for mobile voice and particularly mobile data services. In fact, as you know, I think the Australian economy simply can’t open for business each day without Telstra’s reliable networks in this increasingly digital age.

A bite of the apple

I’m sure I wasn’t alone in recent weeks visiting an Apple store to pick up my iPhone 6 and then trudge over to the Telstra (T-Shop) to get it all switched on. I am not alone in suffering from Mobile Device Addiction (MDA) and the best way to hedge MDA is to own Telstra shares.

Smartphones and smart mobile networks are structurally changing how business is done. For example, why do I type these notes from an office in the CBD? I could type them from my boat on Sydney Harbour (there’s an idea, but I don’t have a boat). My point is smartphones and smart mobile networks (+cloud) are genuine disruptive technology to many traditional business models and we need to think carefully about who the long-term winners and long-term structural losers are. I suspect being long high-end CBD office property isn’t a great long-term idea.

I want to own the enabler of structural change and that is the mobile network owner in Telstra.

I thought CEO David Thodey summed it up well at the conclusion of his AGM speech earlier this week.

“In summary, in 2014, Telstra delivered consistent earnings growth, increased returns to our shareholders and generated strong operating momentum into 2015. Our focus remains on improving on how we interact with our customers, and to have a genuine and positive impact on their lives with our products and services. We believe that focus is positioning us well for long-term growth. This is an exciting time for Telstra and we see a great future for your company as we work to create a brilliantly connected future for everyone”.

Crunching the numbers

In terms of FY15 guidance, Telstra reiterated that it expects to see free cash flow of between $4.6 billion and $5.1 billion and a capex to sales ratio of 14%. They guided to low single-digit income and EBITDA growth, to offset the absence of Hong Kong mobile business CSL 2014 operating revenue and EBITDA. After excluding the $561 million profit on the sale of CSL in 2014, Telstra income and EBITDA guidance for 2015 is “broadly flat”.

In my view, as in the examples of the last few years, that guidance will prove conservative. Analysts will continue to underestimate Telstra’s “positive JAWS” and the conversion of EBITDA to free cash, EPS and eventually DPS/buybacks.

In terms of the current FY15 consensus Telstra investment arithmetic, the EPS forecast is 33.4c. Interestingly, the consensus DPS estimate has snuck up to 30.7c. I am forecasting Telstra generates 34 cents EPS in FY15 and pays an annual dividend of 31c. That is a 1c rise in my previous FY15 Telstra dividend forecast.

Telstra’s P/E has pulled back to 15.7x FY15, which is un-demanding versus other comparable “monopoly toll bridge” Australian stocks (Transurban Group, Sydney Airport Holdings, Wesfarmers, Woolworths), while like for like growth will be equal or better.

The dividend payback

Obviously, most private domestic investors, the investors who dominate Telstra’s register, are in it for the fully franked dividend. Those investors can look forward to another annual dividend lift this year. To me that means how Telstra’s share price performs, comes down simply to what price domestic SMSFs will pay for Telstra’s likely 31 cents fully franked dividend in FY15. Clearly that will be driven by sentiment towards global and local cash rates.

6.00% yield = $5.16

5.50% yield = $5.63

5.00% yield = $6.20

I suspect given flat domestic cash rates, volatile equity markets and volatile bond markets that Telstra’s prospective dividend yield will settle in the 6.00% fully franked to 5.50% fully franked band over the year ahead. With the stock at the bottom end of that prospective yield trading range (5.80%/8.27% grossed up at $5.35) I am upgrading it to buy, expecting a 12-month total return of 10% to 14% including the value of franking credits.

Go Australia. Charlie.

100% of Charlie Aitken’s fees for writing for the Switzer Super Report are donated to The Sydney Children’s Hospital Foundation.

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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