Telstra Corporation Ltd (ASX: TLS) has been one of the most generous dividend payers on the ASX over the last 15 years. Its fully franked dividend is legendary among retirees.
The business has a market-leading position in the mobile and broadband market. There are several reasons to like Telstra, I won't deny that.
However, I think its dividend is too generous for its own good. For the long-term success of the business I think Telstra should reduce its dividend for the following reasons:
Its payout ratio is too high
Telstra pays more than 100% of its profit out as a dividend. In its half-year result to 31 December 2016 it disclosed that its earnings per share were 14.8 cents, yet it paid out a dividend of 15.5 cents per share. This equates to a payout ratio of 104.7%.
No one would suggest that spending more than you earn with your personal finances is a good idea. I think the same can be applied here, a 100% payout ratio is the highest a business should go to.
The money could be used to grow the business instead
Telstra has flagged that it will be spending a few billion dollars over the next few years on maintaining and upgrading its network. It would be a better use of the money to pay for this.
There are several segments to Telstra's business that have promising futures such as Telstra Smart Home and Telstra Health. The money could be used to grow these segments, which would be more likely to produce longer term returns.
It could be used to pay down debt
Telstra has a huge amount of debt on its balance sheet. At 31 December 2016, its gross debt was a total of $16 billion.
I think it would be prudent for Telstra to pay down some of this debt. Interest rates are slowly rising, which could rapidly increase the interest charged each year. This would put the dividend in further danger.
Foolish takeaway
I think Telstra should reduce its dividend to a 100% payout ratio (or less) and not pay any more than that.
However, I doubt Telstra management will make that choice and that's why I don't think Telstra will be a market-beater over the next decade.
