Telstra Now Offering Dividends Plus Buybacks

Australia | 11:53 AM

Telstra's H1 release surprised through an additional share buyback and analysts' confidence in ongoing dividend increases has grown.

-Telstra posts a solid first half result
-Dividend increased as expected, buyback a surprise
-Mobile, InfraCo lead earnings growth
-Share buybacks might be part of the mix in years to come
-Growing competition a threat down the track

By Greg Peel

Telecommunications leader Telstra ((TLS)) reported a "clean" first half result, analysts agree, with underlying earnings up 6% year on year in line with, or slightly better than, forecasts.

The dominant Mobile division grew earnings by 4%, ahead of consensus, mainly driven by strong growth from postpaid service-in-operation (SIO) and increased average revenue per user (ARPU), despite only four months of price increases in the half and disruption from the shutdown of the 3G network.

Jarden, for one, had seen a combination of the 3G network shutdown and the timing of price increases as presenting downside risk to postpaid mobile SIO forecasts, but that did not eventuate.

Telstra highlighted churn of some -190k from the event, while postpaid subscribers grew 48k and postpaid ARPU growth of 0.8% was in line with expectations.

InfraCo earnings were also solid, growing by 7% compared to 2% expectation.

Supporting the result was a strong cost performance, driving return on invested capital of 8.0%. The underlying cost-out continues, with further opportunities highlighted from new initiatives.

Telstra increased its dividend to 9.5c from 9.0c, as expected, but the true surprise came in the form of an announced $750m share buyback. Analysts had foreseen a buyback down the track, but not this quickly.

Cash is King

Management has decided that from now on it will make capital management decisions based on cash earnings per share (EPS) rather than accounting EPS.

Cash EPS is operating cash flow divided by the number of shares outstanding. Traditional, or accounting EPS, is net income divided by the number of shares outstanding. The bottom line is cash EPS does include the impact of D&A expense, which in the case of Telstra's first half result, was higher than forecast, leading to the profit result falling short of consensus despite underlying earnings beating.

Post Telstra's result, Barrenjoey's confidence in the security and growth profile of the dividend has increased, due to buybacks which will support FY26 (and beyond) EPS and cash EPS growth. Operational earnings are tracking ahead and if not for D&A, accounting EPS would have lifted, Barrenjoey notes, but since capex is unchanged cash EPS is actually higher than before.

Ord Minnett sees additional buybacks being supported by reduced balance sheet leverage as asset sales and portfolio restructuring continue ---Telstra has signalled its network and applications (NAS) division as a focus--- and operating earnings increase. The broker's analysis implies FY25 earnings at the top end of the company's guidance range.

Telstra provided further new underlying free cash flow to equity calculations which, in Jarden's view, may provide a framework to forecast future dividend payments. The calculation makes an adjustment for spectrum amortisation (a real cost), however, looks through lumpy one-off spectrum payments. It also excludes strategic investment capex.

Based on this framework, Jarden believes Telstra can sustainably increase the dividend to the mid-20c range by FY28, with franking credit generation the key impediment to a higher dividend. The broker also believes that with earnings growth, Telstra has significant headroom to undertake further buybacks under this framework and remain within its 1.5-2.0x debt servicing comfort range.

Jarden therefore assumes $2.25bn in cumulative share buybacks through to FY28 as a base case. Based on forecasts, Telstra could potentially undertake double this amount, the broker suggests, though this would leave little headroom, noting significant spectrum payments may be required towards the end of the decade if auctions require full upfront payment.

The company is likely to hold an investor day during the second half, outlining its strategy and targets through to 2030, which may also provide further clarity on Telstra's future capital management framework.

Ratings Agencies

The announced $750m buyback will commence from March 12 and proceed over the course of 2025 and management will "evaluate future buybacks". Barrenjoey believes Telstra will de-gear from both earnings growth and asset sales/portfolio optimisation. The first half cash balance reflected the sale of Ventures but not the sale of Foxtel, as yet.

The limiting factor on the amount of any buybacks is likely to be Moody's credit ratios, Barrenjoey notes, given Telstra sat at a gearing ratio of 2.16x at FY24 versus maximum headroom of 2.2x. In comparison, Telstra is one notch lower on Standard & Poor's ratings and, hence, has plenty of headroom to S&P's target ratio of 2.5x.

Barrenjoey thinks Telstra also has headroom under its own "comfort zone" net debt to earnings ratio of 1.5-2.0x. If the company conducted $750m buybacks each year, the Moody's gearing ratio would step down from 2.16x at FY24, to 2.0x in FY25, and then staying at around 2.0x-2.1x over FY26-27. This would be below the 2.2x threshold.

Driving Earnings

A highlight for Goldman Sachs was that despite market concerns around January/February mobile trading, given Vodafone promotional activity and TPG/Optus Multi Operator Core Network launch, Telstra noted subscriber trends remained strong year to date with minimal impact on porting data since the MOCN went live.

Telstra is re-allocating -$800m of capex into mobile over the next four years which should help maintain network leadership by improving reliability, speed and efficiency, with a continued focus on improving mobile return on invested capital.

Into 2025, ARPU should benefit from a full-period impact of price increases.

An announced deal with Accenture should allow Telstra to become a leader in AI which could improve customer service, productivity and margins, UBS suggests. Macquarie understands the majority of the return expected on this -$700m investment is from cost-out, rather than higher revenues.

While the intercity fibre rollout has been marginally slower than expected, Telstra now has seven fibre routes under construction, with the first two routes (Sydney to Canberra and Melbourne to Canberra) to be ready in late-2025. The new routes will enable at-scale delivery of dark fibre solutions and options for wavelength services for customers such as hyperscalers and the broader AI industry.