Telstra: Not so good just yet

PORTFOLIO POINT: Earnings in line with market expectations bring a mixed response from brokers.

Interim earnings from Telstra (TLS) were broadly as the market had expected, the company delivering solid mobile revenue growth and subscriber numbers but continuing to struggle with the Sensis division.

The result was accompanied by management maintaining full-year guidance, which implies low single-digit growth in EBITDA (earnings before interest, tax, depreciation and amortisation). Driving the growth will be solid underlying demand for mobile services, while RBS Australia also sees a more stable pricing environment and benefits from Telstra's continued network advantage.

Given full-year guidance has been maintained and the interim result contained no major surprises, stockbrokers have made relatively modest changes to earnings estimates. For RBS this meant a minor increase to its earnings per share (EPS) forecast for 2011-12 and no change to 2012-13 numbers, while Citi lifted numbers this year by about 4% but cut 2012-13 estimates by 3%.

Consensus EPS forecasts for Telstra now stand at 28.1¢ for 2011-12 and 29.6¢ for 2012-13.

Despite Telstra's result coming in largely as expected, there continue to be a range of views on the outlook for the company. The FNArena database reflects this, showing Telstra is rated as a buy four times, hold three times and sell once.

In the buy camp sits UBS, which argues valuation remains compelling at current levels. On UBS's numbers, Telstra is trading on a price/earnings multiple of 8.5 times in 2012-13 and a yield of 8.2% fully franked, with potential capital management a further positive.

As well, UBS suggests upgrades to consensus earnings estimates are likely as NBN details are digested by the market and the mobile market returns to a more rational pricing environment. This is likely to occur ahead of the implementation of 4G spectrum.

RBS agrees Telstra offers value, with upside potential coming from Project New and the scope for cost savings to be better than currently anticipated. RBS also expects some capital management initiatives once the ACCC agrees to Telstra's structural separation undertaking, an announcement RBS regards as imminent.

Capital management is likely to take the form of share buybacks in the view of RBS, the broker suggesting a program of $500 million to $1 billion per annum is possible depending on the timing of payments from the NBN.

But Citi argues the return outlook is factored into expectations at current share price levels, particularly given the broker's view that capital management is likely to be delayed relative to previous expectations. This reflects a pushing back of expected NBN cash receipts by 12 months, meaning the first significant payments will now arrive in 2014-15.

Free cash flows should cover dividend payments in coming years but, according to Citi, additional capital management measures are unlikely prior to these payments being received. This means Telstra is unlikely to outperform in the shorter to medium-term, particularly as on Citi's numbers the stock is trading in line with the peer multiples of incumbent telcos in developed markets.

To reflect this, Citi has downgraded to a neutral rating on Telstra, from buy previously. But even a neutral rating is excessive, according to BA Merrill Lynch, which remains the only broker in the database with a negative view on the stock.

For Bank of America-Merrill Lynch, Telstra simply lacks visible upside catalysts and the market appears to be discounting any potential downside risks. These include a lack of scope for cutting fixed costs, the fact more than 35% of group revenue is susceptible to digital substitution and the potential for any wholesale DSL declaration and price reset to impact on competitive dynamics in Telstra's markets.

These concerns are more than enough to overshadow what remains a compelling yield, especially as Bank of America-Merrill Lynch doesn't see scope for any capital management initiatives prior to 2013-14 at the earliest. Reflecting its view, its price target for Telstra is $3, well below the consensus target of the FNArena database, of $3.39. This is up from $3.37 prior to the interim result.

Shares in Telstra on Friday, February 12, were strong. The stock was up 3.5% at $3.405 during intraday trading. This compares to a trading range over the past year of $2.57 to $3.45 and sees the stock trading in line with the consensus price target in the database.

This article first appeared in FN Arena, and is reproduced with permission.