Assured earnings a boon for Telstra

Long-suffering shareholders to be rewarded at last. By John Collett.

Long-suffering shareholders to be rewarded at last. By John Collett.

Things are on the up and up for Australia's telecommunications giant. Telstra's earnings will be more assured than at any time since its initial part-privatisation in 1997, with the regulator expected to sign off on the telco's National Broadband Network agreements in the next few weeks.

The chief executive of Telstra, David Thodey, musing over "capital management" initiatives that will flow from the conclusion of the agreements, says the telco will look at a "dividend opportunity" given the increase in cash flow to come from the deal.

For its 1.4 million shareholders, many of whom are long-suffering, the question is whether the big run in Telstra's share price has much more upside.

During last year, the telco's share price increased by about 30 per cent, making it one of the best-performers of the blue-chip stocks.

In March last year the stock hit $2.50 before staging its recovery on investors attracted to the high yield and defensive earnings in the face of Europe's worsening debt crisis and on the greater certainty on the dividends after Telstra "guaranteed" it would pay to 28? a share dividend until the year ending June 30, 2013.

Telstra shares are now trading about $3.30. Analysts are divided on whether there is much more upside for the share price after its big run last year.

"A couple of years ago, before all the trouble with the NBN, the share price was more than $4," a senior client adviser and strategist with Austock Securities, Michael Heffernan, says. "I'm favourably disposed to Telstra and I have been telling my clients that for quite some time. I would say that $4 is not a great stretch for Telstra."

Dividend secure

The annual dividend of 28? a share has been paid since 2006. Analysts like to see companies increasing their dividends but Heffernan says with a fully franked dividend yield of 8.5 per cent, the shares are looking attractive at current prices.

With interest rates going down and the best-paying term deposits paying 6 per cent, Telstra's fully franked yield of 8.5 per cent is going to look even more appealing to investors, says the head of equities research at Morningstar, Peter Warnes.

"We have had a positive recommendation on Telstra for about 2? years," he says.

Warnes values Telstra shares at $3.60 and still has a positive recommendation on the stock.

He says once Telstra completes agreements with the NBN after the expected regulatory approval of plans for "structural separation", the telco will be able to make significant savings on its copper network.

Structural separation will see Telstra progressively give up its fixed-line network and transfer customers to the NBN's optical fibre network. The company will have to outlay significant amounts to renew mobile spectrum licences but mobile usage is growing rapidly, Warnes says.

A portfolio manager of Australian equities at fund manager Fidelity Worldwide Investment, Kate Howitt, says for a stock such as Telstra, which generates a lot of cash, yield is the more relevant way to value its shares. She sees the potential for a higher share price.

"If the market came to view Telstra's dividend as being as secure as those of the banks, then the stock would re-rate to a similar 7 per cent yield, which implies a Telstra share price of $4," she says.

If the market viewed the Telstra dividend as being as safe as those being offered by the other market defensives such as Transurban, Amcor or ASX, then, theoretically, the stock could re-rate to 6 per cent or $4.67, she says.

Share price

An equities analyst at RBS, Fraser McLeish, says Telstra has had a good run and there is probably not much more than another 10 per cent rise in the share price. McLeish has a price target of $3.50 on the shares.

"It is not a stock that is going to put on another 30 per cent or 40 per cent," he says. "It is not going to give huge capital gains but it is going to give investors a safe, solid return."

The editor of Sound Money. Sound Investments, Greg Canavan, says the share price has done well as the market has focused on companies with defensive earnings. The share price before its recent run was heavily discounted because of the uncertainties about the NBN. "I think that the share price is now fully valued," he says.

Canavan recommended the stock as a "buy" until it reached just above $3. "It's still a very good 'hold' just for the dividend income," he says.

The share price could go higher, says an analyst at Fat Prophets sharemarket research, Greg Fraser. "We are not expecting much in terms of earnings growth in the next year but the company is very well positioned for strong earnings growth in the mobile and broadband markets," he says.

On the "capital management" initiative, Canavan favours a special dividend so all shareholders would receive an immediate reward, at the mid-point of what is being talked about, of about 8? a share, in addition to the dividend of 28? a share. Any special dividend would not have franking credits.

Telstra appears to be leaning towards an "on market" buyback, which shrinks its equity base and boosts financial metrics such as earnings per share. Reducing the number of shares has the benefit of lowering the costs to the company of the 28? dividend. More may be heard about the capital management initiatives when Telstra announces its half-year results on Thursday.

$11 billion NBN boost to income

Telstra will be paid $11 billion in the next 10 years to decommission its copper phone network and migrate its customers to the NBN optical-fibre network.

Greg Canavan says the big cash flows Telstra is going to receive from the NBN, as assured income, helps to make its earnings much less risky than other companies'.

The sustainability of the 28? a share dividend becomes more assured because of less capital expenditure needed to maintain its copper network.

Kate Howitt agrees the deal makes the earnings more assured. However, she says Telstra faces challenges with price-based competition in mobiles and there is a risk that Telstra's fixed-line business will decline more quickly in the next few years than the market is expecting.

Want access to our latest research and new buy ideas?

Start a free 15 day trial and gain access to our research, recommendations and market-beating model portfolios.

Sign up for free

Related Articles