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Morningstar | Divided We Stand on Telstra Dividends

Market scepticism regarding the sustainability of Telstra's dividends remains a roadblock to its shares reaching our AUD 4.40 fair value estimate. We are not as concerned. We see the rebased dividend per share of AUD 0.16 forecast for fiscal 2019 continuing until fiscal 2022, the expected earnings low-point year marking the end of the National Broadband Network rollout and the start of its maximum margin-crunching impact.

Our view is not based on outlandish expectations for fiscal 2022. Aggregate legacy EBITDA (fixed-line, data, and IP) is forecast to slump a further 16% from our already-depressed fiscal 2019 estimate. Mobile EBITDA is only forecast to be 7% above our subdued fiscal 2019 estimate, which reflects the current unprecedented competitive intensity. Despite this conservatism, our fiscal 2022 group EBITDA forecast of AUD 8.7 billion is just 3% below our fiscal 2019 estimate of AUD 9.0 billion, aided by NBN receipts and progressive benefits from the current cost-cutting drive.

That AUD 8.7 billion EBITDA expectation in fiscal 2022 equates to EPS of AUD 0.18, covering the forecast AUD 0.16 DPS estimate. The payout will be high at 91%. But it will still be in line with the current policy, with AUD 0.14 DPS from recurring earnings translating to a 93% payout (versus 70%-90% policy) and AUD 0.02 DPS from one-off NBN earnings translating to 75% payout (versus 75% policy). All this while maintaining a solid balance sheet, with net debt/EBITDA forecast to be 1.8 by fiscal 2022, versus management's comfort range of 1.3-1.8.

At DPS of AUD 0.16 from fiscal 2019 to fiscal 2022, the current 4.9% fully franked yield on narrow-moat-rated Telstra's shares presents appeal at a time when the possibility of interest-rate cuts is increasing. There is much heavy lifting ahead as Telstra attempts to transform itself longer term. Market scepticism about whether this will be successful is understandable. However, scepticism about medium-term dividend sustainability is not.

The mobile unit needs to hold up to anchor Telstra's earnings and the annual AUD 0.16 DPS between now and fiscal 2022. We forecast fiscal 2019 mobile EBITDA to be AUD 3.7 billion, down 9% year on year and the third consecutive year of decline. From fiscal 2019, we expect mobile EBITDA to grow at a mere 2% compound annual growth rate to reach AUD 3.9 billion by fiscal 2022. In other words, conservatism has been baked in. The potential upside from a competitive viewpoint is: (1) Optus becoming more rational after it doubled down on competitive aggression ahead of TPG Telecom's (now aborted) entry into the mobile network market; (2) Vodafone could be preoccupied with integrating TPG Telecom (assuming the merger gets regulatory clearance); (3) Telstra's "fight back" strategy for customers discourages irrational discounting; and (4) all the operators are engrossed in the 5G upgrade.

Beyond fiscal 2022, we admit there is a leap of faith required. We have taken that leap and believe Telstra will be successful in cutting its underlying fixed-cost base by AUD 2.5 billion, from the fiscal 2016 base of AUD 7.0 billion to AUD 4.5 billion by the end of fiscal 2022. Progress to date has been good, with fiscal 2019 underlying fixed costs on track to be at or below AUD 6.0 billion. Coupled with further growth in earnings from nonlegacy fixed-line units (for example, mobile, network application services, global connectivity), we forecast fiscal 2023 EBITDA of AUD 9.3 billion, compared with current consensus (rubbery as it may be) at AUD 8.2 billion.

That projection may elicit a sceptical snort from investors. We will not know the answer for at least a year or two where Telstra's earnings may end up by the end of fiscal 2023. This is especially so given the fluid situation on NBN and its economics, and the extent to which 5G mass adoption will facilitate an NBN bypass by resellers such as Telstra. In the meantime, however, we believe the current AUD 0.16 DPS per annum is sustainable.