For many years, no matter which way you sliced or diced it, Telstra Corporation Ltd (ASX: TLS) was ‘the’ dividend delight for Aussie investors.

As interest rates on term deposits hit new lows, the dividend yield on Telstra was, at some points, in excess of 10% after adjusting for tax credits.

 

Data source: Morningstar

 

A Double-Whammy

While the past may appear helpful in making investment decisions — the future is what counts.

With the arrival of the NBN and ongoing competition from rival broadband and mobile providers like TPG Telecom, Optus and Vocus Group, Telstra’s dividend is a hot topic amongst investors.

Unfortunately for shareholders, if Telstra cut its dividend it might be a double-whammy, given how far the share price has fallen in recent years…

Data source: Google Finance

Will They Or Won’t They

Speculation that another dividend cut is imminent reached an all-time high last month when the company told shareholders to expect an operating profit of around $10.1 billion, which was at the lower end of what was expected.

While a $10 billion profit sounds good, I think there may be more going on under the hood than most investors realise.

There are two things shareholders need to know:
1. The ‘NBN effect’ is already starting to squeeze Telstra’s broadband profit margins
2. The ‘TPG and data effect’ could impact Telstra’s mobiles business in a big way

What’s changed?

In the past, Telstra controlled virtually all of the networks. So if TPG, for example, wanted to sell broadband it would have to pay Telstra a small fee for accessing the network and push data around the country. Now that the NBN controls the networks Telstra is forced to compete more aggressively on price.

On the NBN, download speeds of around 25 megabits per second should be accessible in most households. But the new 5G mobile networks could reach almost 1Gbps (1,000 megabits). Telstra, the network operator with the widest mobile reach and most subscribers, could have been expected to benefit from the rollout of 5G mobile.

However, competitors like TPG are attacking the mobiles market by offering more data on cheaper plans in the most populated areas. A few weeks ago TPG announced it would offer customers a free six-month plan with unlimited data (although speeds would be capped). After that, customers would be charged just $9.99 per month.

In 2017, mobile accounted for 40% of Telstra’s revenue, down 3% from the prior year (despite adding more subscribers). I’ll admit Telstra should be able to charge a higher price for its mobile plans because of its extensive network coverage. However, TPG is going directly to the highest value and most populated areas of Telstra’s network. And we’re only now starting to see a narrowing of mobile profit margins.

The Verdict

Telstra has a big chunk of debt, operates in a very price competitive industry, and must invest billions of dollars to keep pace with changes in technology, consumer demands and regulation. Therefore, I think it’s losing its moat.

That’s the bad stuff.

On the flip side, Telstra has confirmed its 2018 dividends will total 22 cents, which would put it on a dividend yield of over 7% (fully franked) — if it can maintain the payment.

Unfortunately, these words from CEO Andrew Penn might suggest the dividend could still go lower:

“…ultimately our ability to pay dividends obviously will be a function of the performance of the business and that’s going to be impacted by obviously the market dynamics.”

“I note we have over the last couple of years returned significant amount by virtue, by way of dividends as well as on market and off market buybacks so we have a history of doing capital management initiatives to make sure that we manage the balance sheet as effectively as possible.”

This week, Telstra’s long-term debt rating was downgraded by Standard & Poor’s.

“The other thing that we are always very cognisant of is to return franking credits which possibly are less well known here in the U.S. but are very important in Australia and we do our best to make sure we return franking credits which are valuable to shareholders as quickly as we possibly can.”

Citi analyst David Kaynes was quoted by Fairfax as saying he believes Telstra needs to take, “quick, drastic action in order to lower the earnings decline and minimise the next dividend cut.”

It seems Kaynes’ mind is already made up: Telstra will be forced to cut, it’s just a matter of ‘by how much’.

I agree that the dividend will be cut. And when it does, Telstra shares might come under more selling pressure.

Therefore, despite Telstra shares falling to seemingly low prices, I’m not rushing out to make a position for it in my family’s portfolio.

Cheers to our financial futures!

Owen Raszkiewicz
Founder & Lead Adviser
The Rask Group

Want My Free Investing Ebook?

Use this link to get my free ebook: “What Warren Buffett’s Investment Checklist Can Teach Aussie Investors”

P.P.S. Here’s a finance joke: What’s the definition of a long-term investment? A short-term investment gone wrong.

 

This article contains general financial information only. That means the information does not take into account your objectives, financial situation or needs. Because of that, you should consider if the information is appropriate to you and your needs, before acting on it. In addition, you should obtain and read the product disclosure statement (PDS) of the financial product before making a decision to acquire the financial product.

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