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Is Telstra a buy – yet?

I get a little worried when I read Telstra’s investors’ presentations which refer to its vision ‘to be a world class technology company’ and its number one strategic pillar that says ‘deliver a brilliant customer experience’. It is not that a company shouldn’t have lofty ambitions and stretch goals, but rather because they are just so, so far away from the actual reality (in both technology and customer service), I start to think that CEO Andy Penn and his team at Telstra must be “smokin” something up in the heights of Level 41 of 242 Exhibition Street Melbourne.

And speaking of “smoky”, that’s the way I would summarise Telstra’s half-year profit result announced on Thursday. They really haven’t done much to clear the air about whether Telstra is on track to meet its NBN earnings and revenue hole.

While Telstra reported that revenue rose by 5.4% on a guidance basis to $14.44 billion and EBITDA by 2.4% to $5.32 billion, these numbers mask the real bottom line. Underlying income increased by just $126 million or 1.0%. Underlying EBITDA declined by $389 million or 8.3%, mainly due to the “recurring” impact of the nbn.

As the rollout of the nbn progresses, Telstra pays higher network charges to the nbn and loses revenue as existing broadband and fixed telephone customers sign up for the nbn service. Offsetting the impact on recurring revenue are the “one-off” connection payments from the nbn, but these start to phase out and are largely gone by 2022.

In the first half, “one-off” payments from the nbn were worth $1.0 billion. These are treated as revenue, allowing Telstra to report both revenue and EBITDA increases.

For shareholders, the 11c interim dividend comprises an ordinary dividend of 7.5c (representing 71% payout of underlying earnings), and an interim special dividend of 3.5c per share, representing 58% of the net “one-off” nbn receipts.

To close the nbn earnings hole (estimated to be around $3.0 billion by 2022), Telstra has cost, revenue and capex initiatives underway. It says that it has delivered $493 million out of a total of $1.5 billion commitment on productivity, and it has invested $1.4 billion out of a total of $3.0 billion earmarked for its strategic investment program. Few details were provided on how this may translate into revenue improvements.

Highlights in the result included strong growth in mobile customers, with 235,000 net new retail customers added. That all said, competitive dynamics meant that mobile services revenue fell by 1.2%. In nbn, Telstra added 454,000 new connections, taking its total nbn customers to 1.6 million and market share to 51%.

Another bright spot was Telstra’s network application services (NAS) business, where revenue grew by 14.1% to $1.68 billion for the half year.

Guidance for the full year was affirmed. Telstra expects revenue in the range of $27.6 billion to $29.5 billion; EBITDA of $10.1 billion to $10.6 billion and net “one-off” nbn receipts of $1.4 billion to $1.9 billion.

What do the brokers’ say?

According to FN Arena, the results were broadly in line with the major brokers’ forecasts. Following the result, some minor revisions to target prices saw the consensus target price reduce from $3.73 to $3.65

There were no changes to recommendations, which sit at 3 buy, 3 neutral and 2 sell.

Credit Suisse believes the dividend of 22c is sustainable for at least the next four years and reconfirmed its outperform rating. Citi, on the other hand, says that Telstra would need to double its productivity target to maintain its dividend and doubts whether this is practical.

Broker recommendations and target prices are set out below.

Is 5G the saviour?

A lot has been written about 5th generation (5G) mobile technology, which could potentially deliver data download speeds up to 50 times faster than the nbn. For Telstra and other mobile carriers, this may allow them to compete against the “monopoly” nbn as well as provide other revenue generating mobile services. But, 5G will also require massive investment in infrastructure and spectrum.

Telstra has established a 5G innovation centre on the Gold Coast and is planning some trials later this year. It has also called on the Government to advance an auction for the spectrum.

However, it is still very early days on 5G, and how Telstra translates the technology into revenue and ultimately EBITDA has some way to go.

My view

As a yield play, Telstra looks attractive. Based on Friday’s closing price of $3.43, it is yielding 6.41% fully franked (9.16% grossed up).

The dividend of 22c looks secure for FY18 and FY19, but I can’t get on Credit Suisse’s page that says it is secure for at least the next four years.

The broker analysts are marginally positive, with the consensus target share price 6.4% higher than the market price.

And then there is the prospect of 5G.

But despite this, I can’t get that positive on management’s ability to execute and can’t see the market moving to re-rate Telstra in the short term. A market underperform – well supported by income buyers in dips, a laggard when the market moves higher.

Growth investors should look elsewhere. Income investors can afford to be patient and buy in dips. Telstra is no bargain – yet.

Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regard to your circumstances.