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Telstra Post Dividend Shock: Now What?

Australia | Aug 22 2017

After all is said and analysed, Telstra shareholders are left pondering the future of their beloved income stock

-New dividend payout policy a negative shock, despite a solid FY17 result
-NBN rollout, competition and growing customer expectations pile on the pressure
-Five-year plan lessens uncertainty, (some) brokers say

By Nicki Bourlioufas

Telstra cuts dividend payout ratio by -30%

Telstra ((TLS)) faces a long-term re-rating as investors come to terms with the telco’s decision to cut its dividend payout ratio over the coming five years, starting this financial year.

Telstra announced a full-year profit of $3.8bn, which was in line with expectations. The company declared a second-half dividend of 15.5 cents, bringing the full-year dividend to the expected 31 cents per share.

But the company surprised the market with an announcement that from FY18, the full year dividend will be 22 cents per share, a cut of about -30%. This is a big blow to retail investors who make up 55% of the share registry. These Mum and Dad shareholders largely bought into the company for the sake of its (perceived) reliable income stream.

Telstra has historically paid dividends of 90-100% of earnings. Its new policy is to pay 70-90% of underlying earnings as ordinary dividends, plus special dividends over time that are equivalent to about 75% of one-off income from the National Broadband Network (NBN).

The planned cut is due partly to the company’s Capital Allocation Review, under which Telstra plans to retain capital to increase balance sheet flexibility. Other factors feeding into the new policy are expected lower earnings due to completion of the rollout of the NBN and increased competition.

NBN rollout is the big bump in the road

Macquarie Wealth Management noted Telstra's challenges are building as the NBN roll-out accelerates. Macquarie expects the company’s Earnings Before Interest and Tax (EBITDA) to fall by about $750 m or -7.6% in FY18, as it absorbs $2.5bn in NBN related costs over the next four years.

As a result, FY19 and FY20 will also be challenging years,” Macquarie said.

By contrast, stockbroker Morgans suggested upside potential springs from the company’s improved capital management. Morgans also proposes a “bull case” which would be realised if competing and substitutive technology reduces the costs of “last mile” connections to the NBN.

This could mean Telstra “does not have a substantial EBITDA hole”.

While Morgans does not include this bull case in its forecasts, the stockbroker said: “We think this bull case scenario is entirely possible.”

Further to fall?

Opinion among analysts is split between those who believe even the planned dividend of 22 cents per share is too optimistic, and a group who argue the payout ratio is sustainable, with the worst news is now out of the way and the dividend yield is still attractive.

Shaw and Partners maintains the 22 cent dividend target is unrealistic, tipping 18 cents instead. Shaw cut its price target from $3.78 to $3.42 and hit the stock with a Sell, commenting, “Reality bites”.

Citi went further, saying the dividend will fall to 17 cents per share in FY22. Citi maintained its Sell and cut its price target to $3.60 from $4.00.

The optimists in the analyst community focused on the certainty the new plan provides.

Credit Suisse trimmed its target price to $3.90 from $4.00 but upgraded its recommendation from Underperform to Neutral on the basis that “the majority of the bad news is now out of the way” and “the 22 cents per share is sustainable for the next five years”.

Morgans upgraded to Add, saying that, although the lower dividend is “disappointing”, it “positions TLS better to navigate the future” and removes uncertainty by providing a firmer basis for market expectations.

Over the next few years, the key operational risks relate to TLS’s ability to offset the negative impacts from the NBN and the increased competition,” Morgans said.

Deutsche Bank more optimistically pointed out that Telstra is still offering a dividend yield 5.4%-6.2% between FY18 and FY20, then 4.9%-5.8% between FY21 and FY25. This “looks attractive and compares favourably to global peers”, Deutsche said.

FNArena’s database has eight ratings for Telstra (Shaw and Partners is not included). The consensus target post the unexpectedly heavy dividend reduction has fallen to $3.92, only a smidgen above the last traded share price. Brokers' price targets range from $3.60 (Citi) to $4.20 (Ord Minnett).

Most have penciled in a dividend payout of 22c for at least the next two years.

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