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Treasure Chest: Telstra And Its Dividend

Treasure Chest | Jun 02 2017

This story features TELSTRA GROUP LIMITED. For more info SHARE ANALYSIS: TLS

Dividend cut or no dividend cut? That is the question. Brokers argue the case.

– Earnings hole ahead
– TPG incursion
– Capital management options

 

By Greg Peel

When Telstra’s ((TLS)) legacy copper network transitions to the NBN, the company will face an earnings hole of $2-3bn. While the company will be compensated for its loss, the question is as to whether future earnings will be sufficient to cover Telstra’s attractive dividend yield.

For realistically, that is the only reason why investors are attracted to Telstra.

In prior years it was assumed Telstra would have no trouble maintaining its elevated payout ratio due to clear dominance in Australia’s mobile market. As demand for land-line connections subsided, the company more than made up for earnings lost in its mobile growth. But more recently, growth has plateaued and the two other mobile network operators have increased their market share.

Then along came TPG Telecom ((TPM)) with its announcement it intended to build a fourth network. If there weren’t already concerns over Telstra dividend being maintained, TPG had investors running scared.

As to whether TPG will actually make a notable impact, and as to whether Telstra can keep up its dividend levels, are questions brokers cannot agree upon. The FNArena database of eight major houses shows two Buy, three Hold and three Sell (or equivalent) ratings on the stock.

Early in May, Credit Suisse cut its dividend forecast to 25c, beginning in FY18, on the basis the forecast earnings profile could not support the current dividend. Telstra paid 31c in FY16.  The broker suggested that on completion of its capital management review, the company would announce $1.8bn in share buybacks from the NBN proceeds to maintain shareholder returns as the transition to lower dividends begins.

It is also Ord Minnett’s view that a large buyback will be forthcoming from the telco. But by contrast, Ords does not forecast any cut in dividend.

Unsurprisingly, Credit Suisse has a Sell rating and Ords a Buy. Back in April, when the Telstra share price tanked on the TPG news, Deutsche upgraded to Buy on the back of a belief that Telstra’s superiority would mitigate TPG’s entry, that dividends would be sustained and a capital return (such as a buyback) would be announced forthwith.

Goldman Sachs (not a database broker) believes TPG will have an earnings impact, and as such forecasts a 28c dividend from FY19. However, Goldman forecasts ongoing 31c payments in FY17-18, while suggesting a buyback could support a dividend of 34c.

Goldman Sachs believes Telstra is in a strong position to successfully navigate an increasingly competitive market. In the company’s favour is a dominant network – the fastest in the country – vast scale, and a domestic-focused strategy. Telstra also hopes to save US$1bn through a productivity program but the broker believes that figure will prove conservative if global precedent is anything to go by.

Recent weakness in share price leads Goldman to suggest valuation is attractive, with a dividend yield that is amongst the highest in the market. The capital allocation review the company is undertaking provides further optionality to crystallise significant value.

The broker is looking forward to the results of the review, expecting an announcement at the FY17 result release in August, and at the same time expects an update on the performance of the productivity program.

In the meantime, Goldman has upgraded to Buy with a $5.00 target.

Ord Minnett also has a $5.00 target, included in the average consensus target among FNArena database brokers of $4.41.

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