Telstra’s Precarious Dividend

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

Following a disappointing FY20, most brokers believe Telstra will be forced to cut its dividend in FY21.

-NBN, virus hit Telstra’s FY20 profits
-Most analysts see dividend cut in 2021
-5G rollout will help boost mobile earnings
-Brokers mixed on Telstra’s value

By Nicki Bourlioufas

The introduction of the national broadband network (NBN), a hit from covid and margin contraction in the mobile business are adding to Telstra's woes and analysts expect a cut to its full-year dividend for fiscal 2021 as the telco experiences an earnings trough.

After its recent disappointing profit result for FY20, analysts are downbeat on the outlook for FY21. Telstra ((TLS)) posted a -14.4% fall in net profit after tax for FY20 to $1.84bn, down from $2.15bn the previous year. Total income decreased -5.9% to $26.2bn while dividends were declared at 16 cents per share including a special dividend of 3cps.

Telstra said the pandemic has cost the telco $200m in earnings this year, while the NBN’s impact totalled $830m. Overall, mobile revenue fell -$461 million in FY20 while NBN migration and a continued drop in voice services affected fixed-line revenue.

According to Morgans, FY21 earnings will be further negatively impacted by covid and strong competition. The broker expects a -15% drop in consolidated earnings (EBITDA) for FY21, which would result in earnings per share falling -37% and its dividend forecast dropping -25%. “We now forecast a 12cps [fully franked] dividend from FY21 onwards.”

In FY21-22, Morgans predicts dividends will be supported by special dividends. After FY23, NBN one-off hits effectively disappear and this would become a 12cps ordinary dividend. “There is upside risk to our DPS target if the competitive environment proves to be more rational than management’s current thinking.”

On the positive side, mobile average revenue per user (ARPU) and EBITDA are expected to improve from the second half of FY21 as Apple’s 5G iPhone is eventually rolled out, which “is likely the main catalyst for TLS customers to upgrade to 5G”. Telstra’s 5G network now covers 53 cities and regional towns around Australia and expanding that coverage will be a key focus in FY21. Morgans has reduced its Telstra price target to $3.21 from $3.73 and moved to a Hold recommendation from a prior Add.

JP Morgan forecasts a full-year dividend of 13cps for FY21, based on a 90% payout of underlying profit, at the top end of the company’s range.  At the current share price, that implies a yield of around 4.2%, “which is not quote ‘overly compelling.’” JP Morgan has downgraded Telstra to a Neutral rating and forecasts the telco’s profit for FY21 will drop -22% to $1.6bn, and by -15% in FY22 to $1.5bn. The broker’s price target is $3.40.

Morgan Stanley is slightly more downbeat and has a price target of $3.00.

Unlike some other brokers, UBS believes Telstra is undervalued and has a price target of $3.70.

“We think recurring NBN payments and mobile alone underpin ~$1 and ~$2 of value respectively.” UBS expects the telco to pay a full-year dividend of 14 cps. Even if Telstra achieves its return on invested capital (ROIC) target, “it would need to operate at the most aggressive end of current settings to support the 16cps DPS.” However, downside “appears limited” for the telco.

But UBS notes headwinds. Telstra’s mobile margins fell by -0.9% to 34.7% due to lower services revenues. However, this was partially offset by lower costs and improved hardware margin. In UBS’s base case, it see an eventual return to industry mobile revenue growth, which would result in long-term earnings per share of 18cps, dividends of 16cps, and a price of $3.70 assuming a ~8.5x EBITDA multiple on mobile.”

UBS’s downside scenario is $2.60, which factors in “continued irrationality in the mobile market. This is still a possibility” if Telstra seeks gross subscriber and revenue growth, rather than boosting its returns.

Also upbeat on Telstra is Credit Suisse. It expects ROIC of 7.6% in FY23 and forecasts underlying EBITDA of $7.6bn, which is within management’s $7.5bn to $8.5bn target range. It expects a 16cps dividend to be retained. That suggests “the updated 7%+ target is consistent with maintaining the dividend at current levels.” While Credit Suisse has lowered its target price to $3.90 from $4.10, primarily to reflect downgrades to its mobile and fixed forecasts, its Outperform rating has been maintained.

Macquarie Wealth Management also has an outperform rating on Telstra. While the FY21 result highlights ongoing operational challenges and covid impacts, it sees a medium-term earnings recovery and strong cash flow supporting its $3.50 target price.

“Whether this outlook will also support the dividend at current levels looks a line ball outcome to us. For the reasons given, we believe it can.” Macquarie is predicting an improvement in mobile ARPU and margins from the second half FY21, helping to offset the drag on revenue from the NBN and its fixed line division.

Macquarie has held its forecast at 16cps for FY21 given strong near term cash flow and solid medium-term outlook and mobile growth, though it flags the dividend position is “very precarious”. To sustain 16cps, Telstra would have to effectively bridge FY21-22 with the distribution of net NBN one-off payments (as per its current dividend policy), and also hold a payout ratio of ~100% (vs 70% to 90%, its current policy). “Again, we think the latter can be justified based on strong free cash flow”.

According to FNArena’s database, the consensus target price for Telstra is $3.45, suggesting 13.9% upside to the last share price. Targets range from $3.00 from Morgan Stanley to $3.90 from Credit Suisse.

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