ASX code: Telstra
Share price: $4.50
Industry: Telecommunications Services
Forecast FY2017 Dividend: 31.0 cents fully franked
ASX code: CBA
Share price: $83.24
Industry: Banking & Investment Services
Forecast FY2017 Dividend: $4.23 fully franked
Two of the market’s most popular dividend stocks headed in opposite directions after reporting their interim results last month. Telstra held its interim dividend flat at 15.5 cents and the stock is down 13 per cent post-result; Commonwealth Bank increased its dividend by one cent to $1.99 and the stock is up six per cent. Both stocks are now ex-dividend. Other major bank stocks are also higher over the last month but the outsize weight of Telstra in many retail income portfolios means the stock is dragging on portfolio performance early in 2017. Telstra’s bottom-line result disappointed market expectations and the company guided towards the lower end of its full-year earnings range.
Prolonged low bad debts expense in the banking sector and the different competitive structures of the banking and telco industries explain the different share price outcomes. The major banks compete on price but still price rationally and are lifting borrower interest rates together, so they can hold interest margins broadly steady despite higher funding costs.
Also technological change in the form of upgraded digital customer interfaces is expensive but not sufficiently large to overwhelm the banks’ ability to find offsetting cost savings and productivity gains elsewhere.
Telstra, in contrast, faces a complex, evolving competitive landscape where rivals large and small are all focused on stealing from its legacy margins and market shares. There is widespread irrational (below cost) price discounting to take share of the new NBN resale market in what the whole industry recognises is a once-in-a-generation opportunity to take marginally profitable share now ahead of hoped-for profitable cross-selling and upgrading later. While data usage is growing rapidly it costs billions in capital expenditure to provide ever more capacity to meet this demand and the rapid pace of technological change adds further to the capex and depreciation bill.
Telstra is steadily losing its highly profitable legacy fixed voice and ADSL revenue streams as customers switch to the NBN. Compensation payments from the NBN are ramping up with the NBN’s rollout but Telstra still faces a $2-3 billion earnings gap after the rollout completes in 2020. The best case is only that Telstra fills this gap and there are plenty of reasons why it might not.
Simultaneously Telstra is struggling to grow profitably in mobile like it used to. In a negative surprise, interim mobile earnings dipped three per cent, the first decline in six years, because customer churn ticked up and average revenue per user fell sharply despite the inclusion of higher data allowances in plans.
And in the meantime there is no growth in the dividend – unlike CBA, which just eked out an incremental rise in the interim dividend and will probably do so for the final dividend as well. We also forecast dividend growth from ANZ though not National Australia Bank and Westpac.
Telstra is a trading buy at a price and around $4.50 we are more interested than we were. For the stock to rerate we would need more certainty about a return to positive mobile momentum, the success of new revenue initiatives and ability to raise the dividend.
So compared with Telstra, ASX major banks, while delivering only low single-digit earnings growth, are a lower-risk proposition for income investors seeking adequate yields and moderate capital growth. This is why the banks trade on 5-6 per cent dividend yields with Telstra trading on 6.8 per cent. It’s interesting this is despite Telstra’s far higher profitability, where return on equity is double what the banks earn.
Originally published in The Australian newspaper, Tuesday 7th March 2016.