Morgans Financial Limited

This August will be a critical time for Telstra (TLS) shareholders, as we will likely hear the Board’s view on dividends and/or capital management in a post-NBN world. Over the next five years TLS's earnings are propped up by one-off gains (disconnection payments) from the NBN, which more than offset the short term NBN margin pressure. Post these one-off gains (and assuming the NBN remains in its current form, which we view as unlikely) then earnings for TLS drop off.

In our view, the million-dollar question is 'Does this capital management framework provide the catalyst to rebase dividends?' We acknowledge that a lot will change in the coming years but think this is business as usual for Telstra.

Refreshed capital management framework due out shortly

After taking on board shareholder feedback for about nine months the Board of Telstra (TLS) is considering its capital management framework with a view to potentially (or not) rebasing dividend expectations for a post National Broadband Network (NBN) world. The outcome of the Boards deliberation is expected before the end of November 2017. We think TLS's August 2017 result is the most logical time to release this. The possibility of a dividend cut (albeit softened with buy-backs and other capital management) is something investors need to be conscious of. Our view is that Telstra will not cut the dividend but some think they will.

Mind the earnings and possibly dividend gap

The reason earnings and the dividend are at risk is that one-off payments from the NBN to Telstra expand from approximately 10% of 1H17 reported EBITDA to approximately 25% in FY21 (on our forecasts). These one-off payments account for a net A$5bn (or A$10bn before tax and TLS's costs) and end around FY21. Without them, TLS's sustainable EPS is less than the current 31 cent dividend.

If the Board is convinced TLS can fill the earnings hole from the NBN (post the one-off gains) then they are likely to hold the dividend. If they think this is an uphill battle, and the 31 cent dividend is not maintainable longer term, they may reset expectations at the release of this capital management framework.

We think the medium term outlook is better than it appears

Our view is that the NBN's financial expectations are likely to disappoint. We expect NBN take-up to be lower than forecast due to competing technologies (which offer better value) and there being fewer premises (a smaller addressable market) than the NBN thinks. In our view, this means that Telstra and others won't have as big a hole in their earnings as predicted because they won't be paying the NBN as much as predicted.

Investment view

In the short term we think the share price risk for Telstra (TLS) lies to the downside. Our FY18 EPS forecasts sit 7% below consensus and we are relatively cautious of expectations heading into the August result and capital management. In the long term, we see upside risk (assuming our views about the NBN are correct). We do not expect a dividend cut but highlight this is a risk heading into the result. We maintain our Hold recommendation.

Contributed by Nick Harris, Senior Analyst. Sectors Covered: Telecommunications, Technology and Financial Services. More insights here: (VIEW LINK)


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