trevor sykes on telstra

NOTE: This was emailed to all Smart Investor (a Financial Review publication) subscribers on 28 Sept 2013:

Anybody who didn't buy shares in Telstra Corporation (TLS) two years ago made a mistake.
Since then, the TLS share price has roared from $3 to a peak of $5.15 and holders have received two 28¢, fully-franked dividends.
Which is all jolly good, but the big question is whether it still worth holding at the current price just below $5. Let's look at the arithmetic and then the crystal ball.
Telstra's chief financial officer, Andrew Penn, gave guidance to TLS shareholder meetings around Australia this week that 2014 revenue and earnings before interest, tax, depreciation and amortisation were expected to show low single-digit growth.
On that guidance, we could expect a small rise in net profit to maybe $4.2 billion this financial year (Ord Minnett's estimate). That would lift earnings per share from 30.7¢ to 33.7¢. On those assumption, TLS shares are currently on a price-earnings multiple of 14.8. About fair value, bearing in mind that price to earnings ratios tend to be a little higher when interest rates are low.
On those earnings per share, TLS should be able to afford to maintain dividend at 28¢. The payout ratio would be high at 83 per cent, but by TLS's standards it's quite modest. For most of the past decade TLS has been paying dividends higher than its profits and had to fund the shortfall by borrowing. Anyhow, maintaining the 28c would put TLS on a yield of 5.6 per cent, grossing up to 7.3 per cent with full franking. A good return in these low interest times.
The final 14¢ dividend posted recently to shareholders is the last guaranteed dividend from TLS. Henceforth the dividend will be decided twice yearly by the board in the light of the group's performance. However, the chief executive David Thodey said: "The board is very conscious of the importance of a fully franked dividend."
Gazing into the crystal ball, the biggest item for Telstra is the $11.2 billion owing by NBN Co for access to Telstra's underground network. Ever since the election, there has been speculation that the Coalition might renege on the debt. This would be almost impossible. For a new government to dishonour a contract of this size would send a dreadful signal to the market and the world.
Thodey said this week that TLS will not accept any reduction in the $11.2 billion (which, far from incidentally, is a net present value number after tax: the actual cash received therefore will be much higher).
The new Communications Minister, Malcolm Turnbull, has been critical of delays to the national broadband network rollout, but has also undertaken to keep TLS shareholders whole. So it looks as though the $11.2 billion is not at risk, although there may well be substantial changes to NBN and the rollout. The changes could even work to TLS's advantage because it is keen to participate in the network's construction.
The telco's biggest business is mobile phones, which increased revenue by 6 per cent in 2013. TLS now has 15 million mobile customers in Australia, so it's still the gorilla in the room.
Note that TLS has another 3.9 million mobile customers in Hong Kong. TLS took a decision three years ago that it had to expand beyond the highly regulated Australian market. Asia was a natural choice, particularly as many of TLS's Australian customers were expanding there also.
The telco's revenues from China grew by 16 per cent last year to $1.7 billion. That's only 6 per cent of TLS's total revenues, but the rate of growth is impressive.
The adverse headlines this week about job cuts arise from TLS's campaign to contain costs. In FY13 TLS revenue rose by 1.88 per cent but its costs only by 0.5 per cent. The differential doesn't look much but in dollar terms it's $230 million, so if it drops to the bottom line it has a big impact on profit.
Looking at negatives, the directory business is making a painful transition from print to digital and traditional fixed line telephones are in long-term decline, although still generating good margins. And, as ever, TLS is fighting international competitors in a business where the technology is changing apace.
On balance, TLS looks a hold but not a sell. My super fund did buy two years ago and it's planning to hang in for a while yet.

[Warning. Trevor Sykes is NOT a licensed investment advisor. Invest at your own risk.]
Disclosure: the author of this article's super fund holds Telstra shares.