Investing is full of choices. You can buy an Argentinian 10yr bond on an 8% yield or Telstra (TLS) on a 6% fully franked yield…I choose TLS.
Today, I want to write about why I think the worst is behind Telstra’s share price and why TLS should deliver solid total after tax returns from this point. I forecast capital gains, dividend growth and franking credits in a world where reliable income streams will continue to be sought.
In an Australian context, I have tried to consistently make the point about dividend growth and dividend sustainability over pure short-term dividend yield. In a world where the average 10yr bond yield is 1.30% (record low), it’s tempting, yet will prove a huge mistake simply to buy high prospective short-term dividend yields. Anyone who bought resource or mining services stocks for yield has learnt this lesson the hard way.
My view remains that interest rates are going to stay low (or even lower) for a VERY LONG TIME. I believe we are in a low growth, low inflation world where governments and corporates are not spending. In fact, they’re cutting back on spending and capex. Most companies favoured share buybacks over capex. Without corporate or government spending, it means the sole tool is monetary policy and as you can see, that’s getting to the point of pushing on a string.
Interestingly, Reserve Bank of Australia Governor Glenn Stevens confirmed that view in a speech in New York this week when he said “it is surely time that polices beyond central bank actions did more in this regard (foster growth)”. In terms of the effect of monetary policy, he also said “but surely diminishing returns are setting in”. He is 200% right in my view and ANY investment strategy that relies solely on central bank largesse is flawed in my view. That’s why my investments focus on structural growth where I can find it in Australia and around the world. There are always companies growing, even slowly, in a world where growth is hard to find and central bank bullets are becoming less and less effective on asset prices.
Obviously, Telstra has been a disappointing performer over the last year. The shares have dropped but I think the worst is behind the share price for a variety of fundamental and technical reasons.
Firstly, the initial move down in TLS was a global sell off in high dividend yield defensive stocks on the view that the Federal Reserve would raise interest rates this year and bond yields would rise. The complete opposite has occurred. The Fed appears on hold and bond yields have raced to new lows.
The second leg down in TLS shares were concerns about the sustainability of the dividend on the basis that TLS management was intent on spending money on new growth initiatives. Recently, the complete opposite has occurred, with TLS backing away from an expansion in the Philippines and also reaping a $2.1b windfall from the sale of their stake in US-listed Chinese car website Autohome (ATHM). Those two events have completely changed perceptions about the sustainability of the dividend and, rightly so, in my opinion.
The final leg down was driven by the series of mobile network outages Telstra had recently and a view that competition was increasing in Australia. While the network outages were unfortunate and frustrating, I remain of the view they were not a sign of any structural problem in TLS network and, most likely, marked the nadir of sentiment towards the stock. I also don’t believe competition has markedly increased in Australian telecommunications and that TLS maintains a major network advantage over all competitors.
During all this noise, consensus analyst forecasts for TLS changed very little. This is an important point. Below is a chart of TLS consensus FY16 EPS estimate and the TLS share price. Note very well that over the last 12 months, the TLS share price has fallen from $6.40 to $5.40 (-15.6%), while EPS estimates are down -4.5%. Also note well the recent POSITIVE EARNINGS REVISIONS FOR TLS (red line). The first in 12 months.
[1]Now let’s look at consensus TLS dividend per share forecasts vs the share price. During the same period, TLS shares fell -15.6% yet consensus FY16 annual dividend forecast fell from 32c to 31.5c, or just -3.1%.
[2]Really, all we have seen is TLS experience a PE de-rating over the last 12 months from around 17.5x to 15.2x.
[3]Conversely, TLS prospective FY16 dividend yield has risen from just under 5.00% (fully franked) to just under 6.00% ff.
[4]Technically, TLS shares have broken a basic downtrend line, while they have also broken the 50 and 100 day moving averages. The important 200-day moving average lies at $5.57 and will be challenged shortly, in my opinion.
[5]Broadly I have confidence in TLS under CEO Andy Penn. I think Andy will sail a steady ship, as evidenced by walking away from the Philippines and booking a huge profit in the sale of Autohome. I also thought he handled the PR nightmare of the network outages pretty well, given the circumstances.
As I mention above, it was very pleasing to see analysts react to these developments by UPGRADING TLS consensus EPS forecasts for the first time in 12 months. To me, that’s a fundamental inflection point in TLS and is a classic example of the knife sticking in the deep value floor. That’s why I picked up the vibrating knife (bought some), even at share prices a little above recent lows.
To me, TLS is all about the dividend and the dividend appears secure. As investors and analysts come around to this view, I would expect TLS to experience a P/E re-rating driven by dividend yield compression. My first price target is the 200-day moving average at $5.57 and if that hurdle is jumped, it is not outrageous to forecast TLS to recover to $6.00, which would represent a 5.25% fully franked, FY17 dividend yield.
It’s worth noting analysts currently forecast TLS’s FY17 dividend to RISE from 31.5c to 32.3c. That’s +2.5% dividend growth in a world where resource dividends are going backwards and bank dividends will be flat at best. Woolworths (WOW) dividend is also at risk, which means almost the entire top 20 in Australia offers flat or falling dividends, while TLS is RISING. This is the key point of today’s note.
The final star that aligns for TLS outperformance is the Federal election. Obviously, long campaigns can create uncertainty and we have already seen Qantas (QAN) warn on domestic demand due to consumer confidence falling ahead of the election. McGrath also warned on very slow Sydney property sales. Whether that’s true or not, it’s a convenient excuse that more Australian companies will use over the next few weeks and months to explain weak sales.
All in all I believe the worst is behind TLS on all fronts and, for the first time, my fund now owns TLS shares. I think they are now cheap and have dividend certainty. I also think they will outperform the ASX200 on a total return basis from this point.
Put it this way, if over the next 18 months the TLS share price did recover to $6.00, the capital gain would be +10% and 18 month dividend yield 8.8%ff. Add on the value of franking credits and there is the potential for a +20% total return in TLS over the next 18 months, if I am right and the recovery continues.
Of course, it all needs monitoring as we progress but I think this is a major turning point for TLS and I’ve put my fund’s money where my mouth is.
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