I'll admit, with interest rates at just 2.5%, the 5.4% fully franked dividend from Telstra Corporation Ltd (ASX: TLS) is looking pretty good. But, as any seasoned investor will know, we must look beyond the dividend yield and get a deeper appreciation of the business and its valuation before committing to a purchase of a stock.
In a market correction (where we experience a drop of 10% or more), I can all but guarantee, stock's with inflated share prices will get hit even harder than the average. Quickly wiping out the perceived benefit of a 5% annual dividend payment.
Here's what you need to know about our largest telco…
Core businesses
Telstra is renowned for its dominant market position and leading service across products such as mobiles, fixed voice, data and pay-tv. Historically, these have been very lucrative infrastructure-heavy products and produced solid cash flows which have funded dividends and re-investment.
However as the NBN Co takes control of Telstra's copper cable network (for which it'll receive a handsome fee) and the company is forced to actively compete against its smaller rivals, market share will come under threat. But in my opinion, Telstra is being well rewarded for these legacy assets, at a time when fixed line communications are becoming increasingly redundant.
The media business – where Telstra's stake in Foxtel lies – is also facing the emerging threat of international rivals entering the market. Netflix is a proven disruptor.
But for the foreseeable future, Telstra's mobiles division – its most profitable – will continue to dominate the market with superior network coverage and customer service. It'll also benefit from the rise of machine-to-machine (M2M) communication and increased data usage.
Growth prospects
Telstra's major growth will come from two divisions, namely, Network Application Services (NAS) and International.
NAS houses services such as unified communications (VoIP), cloud computing and managed network services. Revenue from NAS has almost doubled since 2010.
International is the division responsible for CEO David Thodey's plan to derive a third of group revenues from Asia by 2020. Whilst this strategy has its risks, if the company can leverage its local success and develop relationships with incumbents, it could have significant long-term upside for the company and its shareholders.
Valuation
Telstra shares don't come cheap and despite retreating slightly from over $5.70 in August, I believe Telstra still does not warrant a buy rating. I think it's a quality hold for current shareholders but any price above $4.70 per share does not leave an adequate margin of safety. It's important to remember patience doesn't lose you money.
