Could Telstra Instigate A Buy-Back?

This story features TELSTRA GROUP LIMITED, and other companies. For more info SHARE ANALYSIS: TLS

-Acquisitions slow to materialise
-Cash flow to exceed dividends
-Debt payment vs buy-back
 

By Eva Brocklehurst

What is on the cards for Telstra ((TLS))? A buy-back perhaps? Credit Suisse thinks so. The broker suspects the company will announce a buy-back at the results release on August 14. Previously, Credit Suisse had not forecast major capital management until NBN migration payments ramp up from FY16, but the cost of debt has now fallen and this makes a buy-back more accretive. Moreover, Credit Suisse thinks it is taking longer than the company expected to source acquisitions in Asia.

Citi resumes coverage on Telstra with a Neutral rating and $5.30 target after a restricted period. The broker has reservations about the medium term outlook but thinks, near term, the company has all the levers for earnings growth. Citi also recognises the significance of the cash available after the disposal of Sensis and CSL Mobile. This presents a unique problem for Telstra but Citi is inclined to believe upside is factored into the share price. Hence a Neutral rating.

Telstra had $13.9bn in net debt at the end of 2013 and Credit Suisse calculates net debt of $12.7bn, after taking into account assets sales as well as the $1.3bn in spectrum payments due at the end of 2014 for the 700MHz digital dividend spectrum. This means debt is below the company's target range and there is scope for a buy-back. Moreover, the cost of borrowing has fallen sharply in the last 2-3 months from a tightening of credit spreads and the company should be able to source new medium-term funding at around 4.0%.

Citi forecasts the company sitting on gross cash of $7bn in FY15 and generating around $2bn in excess cash flow over and above dividend payments in the next three years. Citi discounts a material increase to the dividend over the next few years, given the limited franking credits available, but also thinks share buy-backs offer only modest returns because of current valuations. The broker favours acquisitions and/or the retirement of debt but acknowledges these provide debatable value accretion for shareholders.

Telstra continues to gain market share across mobile and fixed broadband as voice revenue declines and Citi thinks there is scope for compound annual growth rates of over 9% for earnings across the next three years. Credit Suisse is less convinced and thinks earnings per share accretion from a buy-back would help offset lower earnings growth emanating from a more competitive mobile pricing environment. Credit Suisse expects a $2bn buy-back, large enough to be meaningful but still leaving capacity for acquisitions. The broker has trimmed mobile forecasts and expects revenue from this segment to be flat in FY15. The more competitive mobile environment increases the operating risk for Telstra but the yield, dividend increase and potential buy-back should all provide support, in Credit Suisse's view. 

Telstra's initial reaction to changes to mobile pricing from Optus ((SGT)) was to reduce handset prices and raise subsidies but this was only meant to be a short-term offer, expiring June 30. The offer has now been extended and Credit Suisse calculates that handset price changes are equivalent to a price reduction of 11-12% on key plans, and the longer the offer is extended the bigger the impact on mobile revenue and earnings. Citi observes Telstra has always encountered stiff competition in mobile from Optus and Vodafone ((HTA)) but has still managed to take market share for the past four years. Admittedly, both competitors are advertising the improved quality of their mobile networks as they ramp up attempts to stem market share losses.

Citi points out it is worth remembering that consumers migrated to Telstra for network quality, not price. Hence, the broker thinks a price-led strategy from the competition is unlikely to be effective. On this basis, Citi expects Telstra to retain market share in mobile for the next two to three years. UBS has also observed mobile and NBN are the key value drivers for Telstra but thinks the easy wins are fast disappearing. The market is valuing mobile too highly for the broker's liking.

UBS has the lone Sell rating on the FNArena database. There are two Buy ratings and five Hold. The consensus price target is $5.22, suggesting 3.9% downside to the last share price. Targets range from $4.35 (UBS) to $6.00 (BA-Merrill Lynch). The dividend yield is 5.4% an 5.6% on FY14 and FY15 forecasts respectively.

See also Telstra Asserts Its Strength In Mobile on May 27 2014.
 

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