Investments

Recent Buy: Telstra Ltd (TLS.AX)

Telstra Corporation Ltd (TLS.AX) is an Australian provider of telecommunications and information products and services, focused mainly on fixed broadband, mobile, data & IP solutions, network and application services, and digital media.

Telstra is an iconic Aussie company and one that became popular (notorious?) with Mum & Dad investors in the 1990’s and early 2000’s when it was privatised by the government in stages. Notorious perhaps because the Government sold shares at $3.30, $7.40 and $3.60 – you’ll notice the share price has gone nowhere since.

Telstra pays a large, fully franked dividend but historically paid out almost 100% of its earnings – occasionally, it’s payout ratio has exceeded 100% – something I loath to see on a regular basis. Nevertheless, Telstra is the most widely held stock on the ASX (i.e. mainly retail ownership) and it’s fair to say, has a love-hate relationship with a lot of Aussie investors.

Company financials

In 2008 Telstra earned $25 bln in revenues and NPAT of $3.71 bln. It paid 94% of earnings to shareholders as a fully franked 28 cps dividend. Return on Equity (ROE) was 29.9% and Return on Capital (ROC) was 12.45%.

Fast forward to 2017 and the company made $28 bln in revenue and NPAT of $3.8 bln. It paid a fully-franked dividend of 31 cents per share at a 95% payout ratio. ROE & ROC are roughly the same, 25.4% and 15.2% respectively.

The share price since 2008 was around $4.00 to 4.90 and today it is around $3.40. During this time shareholders received $2.90 in dividends and approx. $1.25 in franking credits per share. Basically then, Telstra is a juggernaut that has been slow to change course, but in my view, reliable in it’s earnings potential.

Chart generated from UKValueInvestors Company Analysis Spreadsheet, available at UKValueInvestor.com

One of Telstra’s weaknesses is its historic capital allocation. It hasn’t retained earnings to compound them internally at higher rates of return. Instead, they’ve given earnings back to shareholders where shareholders might earn 2-3% in a bank account, or if they’re lucky, 8% in an index fund over time. With some sense, Telstra announced in August 2017 it was changing it’s dividend policy. It would reduce it’s payout ratio to 70-90% of underlying earnings from FY2018 on.

How does Telstra compare to the ASX300?

One of the ways I’ve started investigating companies over the past year is with John Kingham’s help – any ASX company with a 10-year track record can be viewed through his framework, which he has published in The Defensive Value Investor. It’s well worth reading – I like this book so much I have the e-book and paperback. He blogs regularly at UK Value Investor.

John’s approach is to examine a company’s historical revenue, earnings, dividends and return on capital, alongside sensible ratios for debt, profitability, growth quality, and growth rate. It helps identify potential red-flags in a company’s operating methods. John then ranks companies against the FTSE to determine their relative value – the idea is to buy a company that’s superior to the FTSE in terms of quality and growth, at a discount to the FTSE valuation. Johns philosophy is far more thorough than I’ve detailed here, but these are a few key points. I use John’s method alongside a DCF valuation.

My calculation of the ASX300 is that it trades on a PE10 of 17.2 and a PD10 of 27.2. It has a growth rate of 1.4% and growth quality of 52%. PE10 represents the current price to average 10 year earnings and PD10, current price to average 10 year dividend. These ratio’s are a way of looking at long-term earnings and income to the investor, smoothing out fluctuations. When examining companies, growth rate should be above 2% and growth quality above 50%. I chose a slightly different benchmark to the FTSE so my minimums are 2% and 52% respectively.

Telstra has a PE10 of 10.4 and a PD10 of 11.7. Compared to the ASX300, Telstra looks cheap. Telstra has a growth rate of 1.8% – similar to the ASX300 and a growth quality score of 59%. According to The Defensive Value Investor Telstra wouldn’t be bought under John’s method because the growth rate is too low, but only just. You can see I am speculating about earnings and dividend growth over the longer term.

My back of the envelope calculations for Telstra’s estimated intrinsic value is between $3.30 and 3.50. I’m still teaching myself valuation methods so take those with a spoonful of salt.

Why did I buy Telstra then?

Telstra sold it’s fixed line copper and HFC networks back to the Government a few years ago. With the upcoming 5G network there is potential to grow mobile data users considerably. We could end up in a position where people opt-out of fixed line internet and consume much more wireless data. Don’t laugh – my mobile plan currently offers me half my monthly data consumption at half my ADSL2+ cost. And yes, I watch Netflix and HD Youtube.  It might take a few years, but it’s a conceivable scenario if 5G is markedly better than 4G (and it should be).

Telstra has stable earnings history, pays a fully-franked dividend, has reduced it’s payout ratio and if it manages future growth astutely, has some upside potential. Around the current price, I am happy to hold Telstra as part of my growing portfolio.

Disclosure: Long TLS. This post is for entertainment only. Do your own research. Seek personal and professional financial advice when making your investment decisions. I am not an investment professional or financial advisor.

6 thoughts on “Recent Buy: Telstra Ltd (TLS.AX)

  1. Since I purchased TLS is has be very much in the red! I too believe there could be a positive future ahead which is why I’m holding.
    Always interesting to read otherso opinions and how they were formulated so thanks for sharing.

    1. Stock price is down a lot over the past several years isn’t it – like you though, I think it could have a more positive future. I don’t for a moment think TLS will be a 10-bagger but if it grows steadily, it will provide a good dividend yield on cost with some decent price appreciation. An acceptable not stellar return.

      Glad to see you stop by Miss Balance 🙂 enjoy your weekend!

  2. Very interesting choice WF30. We are somewhat tempted by Telstra, but we also can’t quite see how the economics of 5G will work where Telstra is able to make a lot more profit than it is now. Unless automated cars, internet of things can generate good revenue somehow..

    Mr DDU

    1. That’s fair enough Mr DDU. I try and think about probabilities – meaningful profit increases might be 20%, small increase might be 20%, business as usual might be 50%, substantial decline might be 10% – it’s not going to shoot the lights out but a 70% chance of being a decent investment and around 20% chance of working quite well is reasonable to me. Competition is also a concern – it’s in a highly competitive marketplace. Time will tell!

  3. Hi WFT, nice to see someone else sees value in Telstra at the moment! My rationale was also not too similar to your last comment above – I think the upside is better than the downside. And in the meantime, those Fully Franked dividends are very nice 🙂

    1. Hi Frankie – the fully franked dividends are very reasonable right. With the reduced payout ratio and the company retaining some profits, it gives TLS greater strategic flexibility going forward. I’ll be keeping an eye on market share and capital allocation but hopefully in the next 3-5 years the company starts to increase its earnings.

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