Australia | Aug 16 2021
This story features TELSTRA GROUP LIMITED. For more info SHARE ANALYSIS: TLS
After years enduring headwinds from the roll-out of the NBN, Telstra is currently enjoying strong free cash flow. Is it time for a hike in dividends?
-Many positives emerging amid earnings growth for the first time in 4-5 years
-Focus now on restructure, 5G and health opportunities
-Mobile key to delivering Telstra's FY23 ambitions
By Eva Brocklehurst
It has been a while since Telstra Corp's ((TLS)) results inspired so much confidence. After several years of questioning the sustainability of dividends, brokers are now more confident the pay-out will be easily supported by operating earnings in FY22 and FY23.
Free cash flow is running ahead of expectations and Credit Suisse is now of the view this can justify an increase in the dividend from the current $0.16. Admittedly, this could be constrained by the availability of franking credits but the focus now turns to whether an increase is appropriate rather than whether the current dividend is sustainable.
Several items were a "positive surprise" to Morgan Stanley amid mobile revenue and earnings growth for the first time in 4-5 years. These include FY22 growth guidance and the share buyback, as well as the continued exploration of options to unlock value in infrastructure.
UBS asserts an inflection point has been reached following several years of pressure from the NBN. The broker is comfortable that guidance can be underpinned by cost savings, mobile revenue growth (a large part of which will be post-paid growth), a rebound in network application/services income and around $30m of extra recurring NBN income.
The announcement of a $1.35bn on-market buyback was consistent with the company's promise as part of the sale of the towers segment in June.
The highlight for Morgans in FY21 was mobile services revenue and the fact that for the first time in years Telstra delivered a "good, clean result". Underlying operating earnings (EBITDA) of $6.7bn was down -9.6%, yet in line with broker forecasts and above the lower end of prior guidance.
Management remains pleased with the amount of cost reductions and the strong performance of mobiles, noting a diminishing financial impact from the rolling out of the NBN.
Underlying FY22 operating earnings guidance is $7.0-7.3bn, which at the mid point of the range is up 6.7%. This has not allowed for any additional customer support relating to the pandemic, although the company is not expecting FY22 will shape up the same way FY20-21 was affected.
Guidance does not assume a reversal of the $380m in pandemic-related headwinds contained within the FY21 base, UBS reflects, while it assumes a degree of normalisation in FY23.
The company believes the path has been cleared for $7.5-8.5bn in underlying operating earnings and a return on investment of around 8% by FY23. This includes around $50m in non-cash accounting from in-sourcing Telstra-branded retail stores.
FY23 guidance also includes no return to international roaming and Credit Suisse suggests any reversal of these items in FY23 would mean that only limited organic growth would be required to reach the lower end of earnings aspirations.
Macquarie sounds a note of caution regarding Telstra's ambition to reach a mid-teens NBN re-seller earnings margin in FY23, as this requires a number of things to go right, including consumers taking out higher plans, add-ons and cost benefits from digitisation.
Still, the company has exceeded its target for recruiting new capabilities in areas such as software engineering, data analytics, cyber security and artificial intelligence, hiring an additional 1500 personnel.
Telstra is in the process of creating three separate legal entities comprising fixed infrastructure (NBN, fibre & property), towers and the service company. Ord Minnett notes, after the recent sale of the towers, the next monetisation opportunity is fixed line infrastructure.
The broker calculates a value of $46bn, which would be more than Telstra's market capitalisation if it is undertaken at a similar multiple to the towers sale. UBS suspects the investor briefing on September 16 could be the catalyst, as the company will unveil its post-tower strategy.
The broker also expects further detail on 5G opportunities and the fixed infrastructure spin off. Telstra has also indicated it may focus on its health division at the strategy update.
Macquarie notes health is expected to experience organic revenue growth in the high teens in FY22 and Telstra has entered into a binding agreement to acquire Medical Director, a provider of practice management software to GPs. Telstra's "ventures" segment has also invested in 74 start-ups.
Morgans flags the improving industry dynamics and believes Telstra's sum of the parts is now worth more than the current share price. Further steps to extract value include the legal restructure and. while Telstra was aiming to obtain a vote ahead of the AGM on October 12 2021, the broker suspects the may occur later in the year.
More rational industry pricing has surfaced in mobiles and UBS is hopeful this will be maintained, observing a more stable environment is being reflected in the relatively low net additional mobile subscribers in the second half.
In a 5G world UBS believes, with consumer revenue growth currently playing out and materialising upside for enterprise revenue, there is potential for a valuation of Telstra above $4.00. Macquarie points out Telstra's 5G network is now more than twice the size of its nearest competitor.
UBS assesses the market is broadly pricing in Telstra attaining its medium-term aspirations, along with some recognition of the value of infrastructure, and other potential positives such as changes to NBN pricing or more substantial 5G mobile upside are yet to be reflected in the price.
Credit Suisse understands, division-wise, mobile will be key to delivering FY23 ambitions. Mobile now accounts for more than 50% of underlying operating earnings. Also, the broker points out, post-paid net additions in the second half, while less than competitor Optus, did not decline compared with 2020 levels as the latter did.
Credit Suisse recognises the upside for Telstra is not as compelling as it was, say, 12 months ago, but the stock is still trading below valuation and offering a 4% dividend yield. FNArena's database has four Buy ratings and one Hold (UBS). The consensus target is $4.22, suggesting 5.2% upside to the last share price.
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