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Telstra: Still our top blue chip stock

After excellent results, Telstra remains Dean Morel of The Motley Fool’s top ASX20 stock pick.

Telstra is a standout in today’s falling market. In early morning trade Telstra Corporation Limited (ASX:TLS) rose 10 cents or 3.5% in a market that was down 1%. Investors have embraced the strong second half momentum in Telstra’s business.

The One Key Question

Investing often comes down to answering one key question. Of course, you first need to know what the key question is and then, to be successful, you have to answer it correctly.

For Telstra, the key question remains whether their 28 cent dividend is sustainable – I wish the key question was always that obvious!

I’m confident the dividend can be maintained, and that over the medium to long term, the dividend should slowly rise. A share in Telstra entitles investors to 42 cents over the next 13 months. That is a whopping 20% grossed up yield. Putting aside the timing of dividends, Telstra currently offers a 13.6% grossed up yield.

While most headlines focus on Telstra’s profit fall. The real story is in its excellent second half business momentum. Revenue grew 1.9% in the second half and EBITDA grew 0.7%. Telstra added 2 million+ mobile subscribers over the year, and mobile revenue gains more than offset the continued fall in PSTN – their old copper network.

Telstra are focusing on the key drivers as they transform the business. As CEO, David Thodey said, they continue to simplify processes to take costs out of the business so they can serve customers better. While they have a long way to go in customer satisfaction, they are finally heading in the right direction.

Guidance

Telstra guided for low single digit growth in revenue and EBITDA in 2012. They expect $4.5-5 billion in free cash flow, which is the same as their guidance was for 2011. That cash flow easily covers their $3.5 billion annual dividend payment.

The Foolish Bottom Line

Investors should focus on the key question. For Telstra that is whether their dividend can be maintained. Keep in mind that dividends are paid out of free cash flow not out of reported earnings, as some investors mistakenly think. As such, the answer is clearly yes.

Telstra remains my top ASX20 pick and I hope readers of our Take Stock email managed to buy a slice of Australia’s best brand during the recent market selloff.

In the interests of full disclosure, Dean owns shares in Telstra, but is too tight to use their services. The Motley Fool’s disclosure policy is as sane as they come.

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