Telstra: Difficult To Resist

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

In this week's Weekly Insights:

– Telstra: Difficult To Resist
– Overvalued? Undervalued?
– ASX Has Done A BHP
– China Property: Slow Down, No Disaster
– Rudi On TV: The Week Ahead
– Rudi On Tour Visits Brisbane In September

Telstra: Difficult To Resist

By Rudi Filapek-Vandyck, Editor FNArena

Some people might argue it's still about the Big Four banks in Australia. Others might point at Suncorp ((SUN)) which has been paying out a sizeable special dividend three years in a row and analysts are anticipating more next year too.

But I think Telstra ((TLS)) has now become the go-to dividend stock in the Australian share market.

The national incumbent in telephony is large, a well-known household name, carries a positive image amongst investors post the Future Fund exit-related crash to $2.62 in 2010 and, above all, it carries remarkably little direct exposure to the Grand Themes that keep investor minds ticking at night: what if Australian property prices do have a correction? What if the Australian dollar refuses to go down? What if China does experience a proper correction in its property markets?

The main worry for shareholders would have been that the telco had been paying out 28c in dividends since 2007 and annual inflation and rising interest rates (at some point) would reduce the value of those 28c given enough time, but this month the Telstra board opened up a new chapter for the telco and its shareholders by lifting the dividend to 29.5c and adding a $1bn off-market buyback that is supporting the share price right now.

Nothing appeals more in this market than the prospect of rising dividends and more potential for capital management.

As a matter of fact, while strategists and commentators elsewhere continue to seek answers in economic data and geopolitical ebbs and flows to explain ongoing positive sentiment for global equities, I see a strong correlation with funds managers' expectations regarding the next upswing in interest rates in the US. On my observation, a switch back to lower for longer for the Fed funds rate can be held responsible for this latest burst into blue sky territory for US equities.

In Australia, we can take guidance from the changes in Fed policy projections at CBA as illustration of what has been going on internationally in past couple of weeks. CBA still believes the first Fed rate hike will occur in July next year, but after that the path towards higher interest rates will be much slower than previously assumed. CBA predicts the Funds rate will reach 1.0% by the end of 2015 and 2.0% by the end of 2016. These numbers are significantly lower than earlier projections of 1.50% and 3.00% respectively.

If we assume these projections are correct, then what's good for US equities surely cannot be a bad thing for a reliable household name that is Telstra, offering the prospect of ongoing share buybacks and higher dividends? I don't think so either.

Contrary to what one might think, given positive coverage post FY14 release and a strong share price performance (supported by off-market buyback), there's a lot not to like about Telstra.

It's main growth engine remains Mobile and that has as much to do with Telstra's own strategies and policies as with the competitive landscape which softened up since 2011, also because Vodafone, the number three, self-imploded and saw its customers flee in large numbers. Telstra CEO David Thodey says he sees a lot more potential for growth in Mobile, but many in the market are sceptical. What if competitors start getting their act together and fight back? What is hard to deny is that second half numbers showed a slowing growth pace for Mobile, and in fact for Telstra in general.

Telstra's second largest growth engine is the National Broadband Network (NBN), essentially an asset sale that sees the company receive buckets full of cash from the government and cash receivables are set to rise significantly, assuming everything goes to plan. This is the key reason as to why just about everyone feels it's safe to project more dividends and more buy backs in the years ahead. Telstra will be swimming in cash.

Telstra's most exciting growth division -Network Applications and Services, NAS- is still small, too small to make a genuine impact in the short term. NAS did not contribute to Telstra's bottom line in the six months to June.

Here laid bare every investor's conundrum: if things do go pear shaped in Mobile, there don't appear too many other levers available to deliver growth in earnings per share terms, not in the short term at least. But Telstra should have an ocean of cash flows available and this opens up various possibilities to reward shareholders. So many possibilities, in fact, that just about every team of analysts covering the company has set out a different route for the years ahead, varying between rapidly rising dividends (36c anyone?) to stable dividends and more share buy backs in the years ahead.

Building on from the positive experience over the past three years, I think many investors are going to find Telstra too difficult to resist, despite funds managers and (some) analysts questioning true growth potential from here onwards. On current consensus, which is essentially the middle ground between all variations put forward by analysts, Telstra shares are -despite their popularity- still offering 5.4% this financial year, rising to a projected 5.7% next year. Plus franking. Plus (potentially) additional share buy backs.

Below are five charts taken from analyst research post the FY14 release I think combined sum up the Telstra investment case today.

First up is a general overview of what makes "Telstra" in financial terms.

The second chart reveals how the mobile market hasn't genuinely grown for a while now in Australia.

The third shows how Telstra has blown away the competition in Mobile since H2 2011. What comes next?

The fourth shows what can become Telstra's problem of tomorrow: the battle against rising costs.

And finally, projected cash proceeds from the government because of the NBN agreement, about to hit Telstra's bank account. What to do with all that money?

Overvalued? Undervalued?

Don't be fooled by share market indices surging into blue sky and all that market noise about a correction being imminent, the outlook for global equities remains buoyant even as the Federal Reserve starts hiking rates from next year onwards. Such is underlying sentiment from a recent strategy update from UBS in the US. The strategists looked specifically into historical precedents and investor behaviour around share market peaks and imminent Fed rate hikes and have come to the conclusion that investors shouldn't worry too much.

More specifically, "The facts are that while stock markets are at all-time highs, valuations are not stretched and earnings continue to rise. Global central banks, including the Fed, appear more likely to err on the side of easier policy. And flows from cash “sitting on the sidelines” are yet another potential source of further equity market upside", say UBS strategists.

But what about the Shiller CAPE ratio which is often referred to by those who think the likes of UBS are simply being complacent, or talking up their book? Nobel laureate Robert Shiller likes to calculate market PE on the basis of average inflation-adjusted earnings from the previous ten years. On this basis, US equities look far from cheap (see chart below).

Jeffrey D. Saut, Chief Investment Strategist at US-headquartered financial advisory Raymond James, firmly believes CAPE is significantly overstating the potential overvaluation of US equities because of the disastrous declines in profits in 2008 and 2009. All this probably shows the real danger of taking guidance from one single indicator only.

Saut's recent strategy update on CAPE and other matters, also contained the following quote from Sterling Professor of Economics, Yale, Robert Shiller: "When there aren’t enough good investing opportunities, people wishing to save more for the future may succeed only in bidding up existing assets, even if they think they’re overpriced. Call it the 'life preserver on the Titanic' theory."

ASX Has Done A BHP

In our series of "old reflexes that no longer apply" we take the opportunity to highlight the fact that ASX ((ASX)), the operator of the main stock exchange on Australian soil, hasn't been able to grow earnings per share since 2011 and it's not like there has been an offset through a consistent pattern of dividend increases (quite the opposite). Whatever happened to the oldest of old reflexes that if the share market was going up, buy the ASX?!

A change in competitive market dynamics is probably one part explanation. The fact that volumes for the exchange of shares kept falling year after year would be another part of the story. Despite IPOs listing in a frenzy this last twelve months and with the retail investor making a come-back (after all, the share market is at new six year highs), most stockbroking analysts can only get lukewarm, at best, on the ASX's growth outlook. Single digit seems to be the new paradigm.

Looking at the price chart since 2009, ASX shares have "done a BHP" over the past six years, swirling up and down between $30 and $40, but essentially going nowhere. Luckily, for long time loyalists, the shares yield 5% thanks to a 90% payout ratio. Maybe the board can take another leaf from the BHP blue print: are there any possibly undervalued assets that could do better in a non-ASX related environment?

China Property: Slow Down, No Disaster

The latest expert to express a view on the current slow down in China's property markets is AllianceBernstein who, through its Hong Kong-based fixed income analysts, reports that Chinese property is not a disaster waiting to happen. For starters, many households pay cash and upfront before their property is built. This brings a whole different dynamic to the market (as one can imagine). Secondly, ongoing urbanisation means there's no shortage in demand and any misallocation should be able to correct itself on a medium term horizon.

The main risks stem from lower quality developers, which are more reliant on shadow banking and from regulatory policies that can be ill-advised or have unforeseen consequences. AllianceBernstein seems convinced it'll all turn out more like a storm in a tea cup event, rather than a GFC II, the Chinese version.

Rudi On TV: The Week Ahead

On request from readers and subscribers, from now onwards this Weekly Insights story will carry my scheduled TV appearances for the seven days ahead:

– Wednesday, Market Moves, 5.30-6.00pm
– Monday – Sky Business – circa 11.20am (Broker Calls)

Rudi On Tour Visits Brisbane In September

On Wednesday, September 3, I will be presenting in Brisbane twice. First at 2.45pm on invitation of the Australian Investors' Association (AIA) and later in the evening on behalf of the Australian Technical Analysts Association (ATAA)).

The first presentation at 2.45pm:

Venue: Bronco Leagues Club, Fulcher Rd Red Hill
Two speakers: One at 1.30pm for one hour and I am at 2.45pm for an hour.

The second presentation runs from 6.30-7.30pm and continues from 7.45-9pm.

Venue: Fitzy’s Tavern at Loganholme

(This story was written on Tuesday, 25 August 2014. It was published on the day in the form of an email to paying subscribers at FNArena).

(Do note that, in line with all my analyses, appearances and presentations, all of the above names and calculations are provided for educational purposes only. Investors should always consult with their licensed investment advisor first, before making any decisions. All views are mine and not by association FNArena's – see disclaimer on the website)

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THE AUD AND THE AUSTRALIAN SHARE MARKET

This eBooklet published in July 2013 forms part of FNArena's bonus package for a paid subscription (excluding one month subscriptions).

My previous eBooklet (see below) is also still included.

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MAKE RISK YOUR FRIEND – ALL-WEATHER PERFORMERS

Things might look a lot different today than they have between 2008-2012, but that doesn't mean there are no lessons and conclusions to be drawn for the years ahead. "Making Risk Your Friend. Finding All-Weather Performers", was published in January last year and identifies three categories of stocks that should be part of every long term portfolio; sustainable yield, All-Weather Performers and Sweetspot Stocks.

This eBooklet is included in FNArena's free bonus package for a paid subscription (excluding one month subscription).

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