Is Telstra Just A Yield Play?

This story features TELSTRA GROUP LIMITED. For more info SHARE ANALYSIS: TLS

-Cash generation supports returns 
-Mobiles underpin growth
-Share price hard to justify
 

By Eva Brocklehurst

Telstra ((TLS)) is riding high despite the competition that is mounting in its mobile and broadband segments. Brokers are aware of how attractive the stock is to global income funds – with a dividend yield circling 5.0% – but, looking ahead, wonder whether the market is complacent.

First half results were solid and the medium-term operational outlook is stable. Cash is being generated, which should support capital returns. Citi expects Telstra can deliver earnings growth supported by NBN receipts, further cost rationalisation and lower interest costs. Nevertheless, this momentum will fade in future periods and while the broker gives management credit for being suitably cautious in a changing landscape, with the share trading at a premium valuation a Neutral rating is considered appropriate.

Morgan Stanley puts it plainly. Telstra's dividend yield is 85% higher than Australia's 10-year government bond yield, which in turn is 135% higher than the average of AAA-rated sovereigns. Accordingly, the stock is sought after on the basis of forecast FY15 and FY16 dividend yields, despite the fact the valuation is expensive, which reflects the attractive balance sheet and potential for capital management options. What if economic growth improves? This would add inflationary pressures and long-term bond yields would improve, decreasing the relative attractiveness of Telstra's yield.

Mobiles were the star attraction in the first half and carried the result, as 4G data was monetised. The results suggest consumers are paying to use more data. Morgan Stanley observes Telstra stands to gain up to five percentage points of iPhone share with the launch of iPhone 6. While no dividend guidance was provided, the broker expects the trajectory has been underpinned for the foreseeable future. In Macquarie's view mobiles underpin Telstra's growth story, with service revenue in the division up 7.4% in the half and reversing the slowing trend witnessed in the prior half.

Outside of the mobile segment, Macquarie suggests the business is shrinking and Telstra will need new growth drivers eventually. The broker concedes this is not a concern while the stock holds its attraction for yield-seeking investors. The broker considers the dividend policy is conservative, with management intent on delivering sustainable growth in dividends. JP Morgan has a Neutral rating. The stock trades above valuation but the broker's forecasts are conservative. Dividend support may be strong but there is the debate about margin sustainability. JP Morgan does not believe this adds up to a catalyst for a de-rating, although admittedly struggles to envisage much upside.

The momentum in the results was solid but Deutsche Bank considers this has been more than factored into the share price which makes the current level hard to justify. The price is implying a 7.0% per annum increase to the broker's forecasts over the next three years which, given increasing competition and the lack of competitively priced product in mobiles and broadband, appears unlikely. Despite the struggle to justify the price the search for attractive yields keeps the broker's recommendation at Hold.

The result may strong and the dividend hardy but Morgans downgrades to Hold from Add, following the run up in the share price, and pending further catalysts. The company's success in the mobile sector looks to be durable, for a period, while fixed line voice revenue was steady and growth occurred in broadband and data. NBN payments have also begun to rise. The broker observes upside risks include growth in regional services and NBN payments while downside risks revolve around mobile competition and the higher cost to serve and retain customers.

The company has several years of steady and reliable low-to-mid single digit growth ahead, in Morgans' opinion. The broker is also confident the company has the operating performance potential to increase the FY15 final dividend to at least 16c per share. Telstra has reactivated its dividend reinvestment program and will meet demand for this program through on-market acquisition. Capital management potential remains higher for FY15, in Morgans' view, despite the increase in the dividend.

Credit Suisse notes the strong revenue but also that cost growth is high. The broker retains an Underperform rating to reflect the high multiples relative to the earnings growth profile and increased competitive risk in mobile. The stock is expensive on all measures, despite the sound fundamentals, and for this reason UBS retains a Sell rating. The broker's response to the vote for a yield hovering around 5.0% is that it is only appealing when the environment is low yielding.

So what is the dividend yield? On FNArena's database the consensus dividend yield on FY15 and FY16 estimates is 4.7% and 4.9% respectively. The consensus target price is $5.79, suggesting 11.9% downside to the last share price and compares with $5.48 ahead of the result. There are no Buy ratings but six Hold and two Sell.
 

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