3 reasons why I wouldn’t buy Telstra Corporation Ltd at the current share price

Source: Telstra presentation

The Telstra Corporation Ltd (ASX: TLS) share price is steadily getting more attractive, is it time to buy? Deciding what price to buy into a share of a business is extremely important. It could be the difference between a capital loss and a capital gain.

If you buy into a growing business like REA Group Limited (ASX: REA) then the share price will hopefully keep growing. However, if you buy a slow-moving blue chip like Telstra then it’s extremely important to get your purchase price right.

Telstra has a huge market capitalisation of $55 billion, however its share price is down by around 30% since February 2015. Even with this steep decline, I am very wary of buying at the current share price.

Here are my three reasons why I wouldn’t buy Telstra at the current share price:

The dividend is not secure

Investors think of Telstra as being one of the best dividend stocks on the ASX. It has maintained or grown its dividend every year since 2007. It currently has a trailing grossed-up dividend yield of 9.54%. These factors make Telstra’s dividend quite appealing.

However, management disclosed that its dividend payout ratio was 105% in its half-year results to the 31 December 2016. This means it’s paying out more as a dividend than it’s earning in profit. This is not sustainable, if it continues paying out more than it earns then it will hurt the balance sheet and share price.

This can be ‘fixed’ in one of two ways, the profit needs to be increased or the dividend needs to be decreased. I think there is a high chance that the dividend will be decreased because of my next reason for avoiding Telstra.

Capital Expenditure

Telstra has flagged that it’s going to spend around $3 billion of additional capital expenditure over the next two years.

Management said it would spend more than $1.5 billion on investing in the network for the future, approximately $1 billion on ‘digitisation’, and that it would spend up to $500 million on improvements to the customer experience.

Investing in the business is a worthwhile cause. It should have a much better long-term impact on Telstra than share buybacks. However, it does mean $3 billion additional expenditure that will hit earnings and make the payout ratio even worse if Telstra tries to maintain the dividend.

Increasing competition

Telstra is losing customers from its profitable fixed-line business and now it has to compete for customers on the NBN. Telstra no longer owns the majority of infrastructure, so it doesn’t have an advantage over Vocus Group Ltd (ASX: VOC), TPG Telecom Ltd (ASX: TPM) and other low-cost providers.

Management will also find it difficult to increase revenue in its main segments such as mobile and broadband. Moreover, the growing parts of the business, such as e-health, are far too small to make up the capital expenditure that’s planned.

Foolish takeaway

If Telstra’s profit and dividend decreases, its share price is likely to follow. I’d rather buy growing businesses than ones which have problems looming. I think Telstra could have a good long-term future, so it may be worth a buy if the share price was at least 10% lower at around $4 to $4.20.

Telstra is an ok blue chip, but I’d rather fill my portfolio with quality businesses like these three great companies.

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Motley Fool contributor Tristan Harrison has no position in any stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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