-Telstra looks solid
-Potential for increased dividend
-NBN value should hold up
By Eva Brocklehurst
Dominant Australian telco Telstra remains on solid ground in 2013 and should retain its value position with ergard to the NBN (national broadband network) this year, according to most brokers. JP Morgan notes, even if Telstra's share of NBN retail broadband services (household and small business) falls to a forecast 32.5%, compared with an earlier 46%, it does little to move valuations. A 1% shift makes a difference of 2c. So what excites brokers going forward? It's the prospect of increased dividend payments.
Macquarie is most upbeat on the company's ability to pay increased dividends going forward, expecting increases are likely from FY14. The broker believes Telstra will be strongly generating cash over the medium term and franking credits are not a barrier to increasing dividend levels. Furthermore, on the back of increasing the ordinary dividend to 30c (from 28c in FY13), Macquarie finds scope for a 2c special dividend, rising to 8c by FY17, assuming little change to the NBN deal structure. Macquarie has raised its target price to $4.30, topping the FNArena database range, to reflect both market and stock-specific factors.
Ahead of the first half result, UBS is also of the belief that dividends can increase in FY14 and has marked its forecast up to 30c, with 32c in FY15. UBS notes Telstra has bounded off a low in November 2010 and now trades at a 12% premium to the long-held $4.00 discounted cash flow value. Therefore, the broker finds further share price appreciation is limited in the near term. A more rational pricing environment, market share momentum, cost out and 4G upside have now been priced in. Hence, a Hold rating is maintained.
Meanwhile, CIMB sees a potential change in government as the key issue for 2013. This could create some uncertainty around forecast payments from the NBN, although the broker does not believe any change would provide a significant risk to the value of Telstra's $11bn NBN deal. CIMB has raised its price target to $4.15 (from $3.85) and sees investor demand for yield supporting the stock price in the near term. Nevertheless, the broker has moved to a Sell rating from Hold as, on an FY13 price/earnings ratio of 15 times there is limited valuation support at these levels. On the story of dividends, CIMB expect a more modest improvement, up to 29c in FY14 and 30c in FY15, calculating there is sufficient cash flow and earnings per share (ie franking credits) to support this.
JP Morgan is at the softer end of the scale, believing many industry observers over-estimating the returns that will be achievable on NBN products because they are used to looking at capital-intensive businesses with oligopoly characteristics. Moreover, this broker says forecasts for earnings margins of 20-30% seem unrealistic given the low capital intensity of NBN participation. JP Morgan is aware that investors may be asking whether buying Telstra for yield could prove to be a mistake if fixed line returns are re-based radically. While being conservative about returns, the broker thinks the valuation can withstand this, although notes that the share price has now drifted above the broker's June 2013 price target of $3.97.
As for the dividend, JP Morgan is not going out on any limb, simply noting that the 28c dividend would be covered by free cash flow until FY22 and by earnings until FY21. Once NBN disconnection payments run down, free cash flow falls sharply. The broker admits this makes Telstra an unusual investment, as it is effectively selling part of its business (fixed line customers), returning capital to shareholders and ultimately growing off a much lower earnings base. One challenge this poses, according to JP Morgan, is that valuation multiples, including yield, do not work well for Telstra, as they imply that the cash flow is ongoing. The broker is sticking with a discounted cash flow valuation.
Overall, Telstra serves up six Hold recommendations on the FNArena database and two Sell (CIMB and BA-ML). The target price ranges from $3.50 (BA-ML) to $4.30 (Macquarie). According to FNArena's Stock Analysis, on current FY13 forecasts and current share price, Telstra is offering a fully-franked yield of 6.2%, rising to 6.4% on FY14 forecasts.
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