Brokers Increasingly Confident Of Telstra Buy-Back

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

-Uncertainty over subsequent Autohome bid
-No large investments in train for Telstra
-Question of the quantum of any return
 

By Eva Brocklehurst

Telstra Corp ((TLS)) is reducing its stake in Chinese online automotive business, Autohome, the rationale being that Autohome would benefit from a strategic investor as it enters the next stage of its development. Telstra believes now is the time to crystallise value for shareholders.

The company has sold a 47.7% stake to Ping An Insurance for US$1.6bn, retaining a residual 6.5%. Telstra expects to book an accounting gain of $1.8bn in the second half of FY16, having acquired a majority stake in Autohome in 2008.

Telstra's operating earnings will be negatively affected in terms of the growth profile, Macquarie notes, as Autohome earnings in Australian dollar terms grew by 64.3% in FY15 and 47.3% in the first half. The broker calculates that even from a relatively small base, this contribution was meaningful.

Yet Telstra's timing of its exit reflects a changing business model in Autohome, which has moved away from a pure online business to a more capital intensive one. The evidence that this affected near-term growth and margins was noted in the last reported quarter.

Moreover, Macquarie does not believe Autohome holds any strategic significance for Telstra, either in terms of its core telco business or its broader expansion plans in Asia. The divestment is around 3-4% dilutive in isolation but, and the majority of broker's agree, this is likely to be offset by capital management.

Macquarie, assuming a re-deployment of $2bn in share buy-backs, assesses the offset would be 160-200 basis points, making the net dilution modest. The sale is also likely to reduce gearing to 1.2 times earnings by June 30, below target ratio levels.

Telstra's excess cash has also grown as it recently abandoned plans for a US$1bn investment in a Philippines joint venture. NBN cash flows are also increasing materially and this adds more certainty to broker expectations of a significant capital management program. Macquarie previously assumed $4.6bn would be returned, via buy-backs and special dividends over the next three years, and now envisages further upside to this number.

Ord Minnett has raised its buy-back assumptions to $6bn over the next three years. The broker marks out three areas for investors to focus on going forward: the heightened competitive environment in mobiles; a step-up in operating expenses as the company invests to replace the upcoming reductions in earnings from the NBN; and capital management options.

Morgan Stanley welcomes the company's more conservative approach, forgoing the Philippines investment and now the sale of this stake. A renewed share-buy-back program would make the broker more positive on the stock.

Subsequent to the sell-down of Telstra's stake, the Autohome CEO, in a consortium with private equity, has made a takeover bid for the company. The bid price is US$31.50 per share versus Telstra's proposed sale price to Ping An of US$29.55 a share.

If Telstra goes ahead and sells its stake it would receive cash before June 30 2016, making this available for capital management, but Morgan Stanley suspects this second bid might prolong the process and awaits further clarity from Telstra on the potential timing issue.

The next step for the broker to become more positive is for excess capital to be allocated to buy-backs. The most important aspect to this would be the improvement in Telstra's organic returns on equity (ROE), ex NBN payments. Morgan Stanley forecasts organic ROE to fall to 23% in FY20 from 26% in FY15. Buying back $2bn in stock would mean ROE remains broadly flat.

Telstra has certainly indicated it remains committed to a capital management strategy, Deutsche Bank maintains. Moreover, credit metrics are now well below internal target levels and there are no large investments on the cards since the negotiations ended in the Philippines. Given the low franking credit balance, this broker, too, expects any capital return would be in the form of a share buy-back.

Nevertheless, Deutsche Bank expects management will only return a portion of the available capital as it chooses to retain the flexibility to make investments in Asia and to support the Australian business, which has encountered increased competition and recent network issues.

FNArena's database shows one Buy rating (Morgans) for Telstra. There are five Hold and two Sell. The dividend yield on FY16 and FY17 estimates is 6.0% and 6.1% respectively. The consensus target is $5.40, suggesting 2.0% upside to the last share price. Targets range from $5.00 (Morgan Stanley) to $5.86 (Morgans).
 

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