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Why Telstra is a classic "annuity" stock

Given the overall market volatility over the last 12 months, Telstra has been trading in a remarkably narrow range. Find out if you should add it to your portfolio.

Telstra’s share price graph says so much about the stock. Over the last 12 months, it has traded in a range of $3.80 to $4.20, in fact, spending most of the time between $3.85 and $4.10. Given the overall market volatility, that’s a remarkably narrow range.

Telstra Corporation Limited (TLS)

 

Last week’s profit result removed any remaining uncertainty about the dividend. By electing to increase the final dividend from 8c to 8.5c (and the full-year payout from 16c to 16.5c), the first increase since 2015, the Directors signalled their confidence in the ability of Telstra to generate sustainable earnings (and cash flow).

Telstra’s dividend comprises two components – an ordinary dividend from underlying earnings and a special dividend that represents a return of the ‘one-off’ receipts from NBN connections. The latter has almost come to an end, and in FY22 only totalled 3c per share (down from 6c in FY21). But by increasing the ordinary dividend component from 10c in FY21 to 13.5c in FY22), the Directors confirmed that the total dividend is safe and in FY23, will be at least 16.5c.

And that’s what makes Telstra a classic ‘annuity’-style stock. Very low price volatility combined with a high degree of confidence about the income (dividend) return. Almost like a bond.

For 2022, Telstra reported a decline in income of 4.7% to $22.0bn and a fall in EBITDA of 2.5% to $7.3bn. But adjusting for material ‘one-offs’, on a guidance basis, underlying EBITDA increased by 8.4% to $7.3bn. Importantly, the “half-year on half-year” growth continued – with the second half underlying EBITDA of almost $3.8bn up from $3.5bn in the first half and $3.3bn in the second half of FY21.

The mobiles business was the star, accounting for 55% of Group EBITDA. Product simplification, leadership in 5G and an easing of competition following the merger of TPG and Vodafone drove a 6.4% increase in mobile services revenue. Telstra added almost 400,000 net mobile services and increased ARPU (average revenue per user) across all segments.

Operating expenses fell – with underlying expenses down $863 million or 5.7% to $14.3bn. The second half was flat on the first half.

The performances of the fixed business products disappointed, with the Consumer & Small Business area (NBN bundles and data) only contributing $55 million in EBITDA. It lost a net of 87,000 customers. Telstra says this has “bottomed”, with ARPU growth, customers moving to higher plans and 5G home wireless making a positive impact.

There were also marginally lower contributions from InfraCo (the infrastructure business) and Amplitel (the 51% owned mobile towers business).

Looking ahead, Telstra provided the following guidance for FY23:

  • Total income of $23.0bn to $25.0bn
  • Underlying EBITDA of $7.8bn to $8.0bn
  • Capex of $3.5bn to $3.7bn
  • Free cashflow $2.6bn to $3.1bn

Guidance includes an 11.5-month contribution from Digicel Pacific, which on a proforma basis is EBITDA of $330 million.

What do the brokers say?

The brokers are generally positive on Telstra. According to FNArena, of the six major brokers who cover the stock, there are four ‘buy’ recommendations and two ‘neutral’ recommendations. The consensus target price is $4.38, 9.5% higher than Friday’s closing ASX price of $4.00. Target prices range from a low of $3.80 from Macquarie through to a high of $4.60 (from Morgans, Morgan Stanley and Ord Minnett).

The brokers assessed the FY22 result as a small “beat” on expectations, with the increase in free cash flow and dividend being highlighted. Guidance for FY23 was marginally lower than some brokers were anticipating.

Following the result, two brokers marginally increased their target prices, two marginally lowered them and two kept them unchanged. Most brokers lifted their dividend forecasts – 17c for FY23 and 18c for FY23.

On multiples (based on a $4.00 share price), they have Telstra trading on a multiple of 23.5x forecast FY23 earnings and 21.2x forecast FY24 earnings.

The prospective yield is 4.25%, plus franking.

Bottom line

You are never going to get rich by owning Telstra. However, with earnings now growing and dividend certainty, it is increasingly looking like a low-risk investment asset.

In market downturns, Telstra should hold up pretty well, and conversely, in market up cycles, it will be a laggard. But that relative ‘capital stability’ and the brokers’ implied valuation suggest that the risk is to the upside.

Telstra is a “buy” for income investors as part of a diversified portfolio, and is reasonable value for investors looking at the make-up of their core portfolio. Plus, a spin-off of the infrastructure business (Telstra Infra) or divestment of Amplitel could be the icing on the cake.

All prices and analysis at 15 August 2022.  This information was produced by Switzer Financial Group Pty Ltd (ABN 24 112 294 649), which is an Australian Financial Services Licensee (Licence No. 286 531This material is intended to provide general advice only. It has been prepared without having regard to or taking into account any particular investor’s objectives, financial situation and/or needs. All investors should therefore consider the appropriateness of the advice, in light of their own objectives, financial situation and/or needs, before acting on the advice. This article does not reflect the views of WealthHub Securities Limited.


About the Author
Paul Rickard , Switzer Group

Paul Rickard is a co-founder of the Switzer Report. Paul has more than 30 years’ experience in financial services and banking, including 20 years with the Commonwealth Bank Group in senior leadership roles. Paul was the founding Managing Director and CEO of CommSec, and was named Australian ‘Stockbroker of the Year’ in 2005. In 2011, Paul teamed up with Peter Switzer and Maureen Jordan to launch the Switzer Report, a newsletter and website for share market investors. A regular commentator in the media, investment advisor and company director, he is also a Non-Executive Director of Tyro Payments Ltd and PEXA Group Limited.