Why I think the Telstra Corporation Ltd share price now looks cheap

The shares of Telstra Corporation Ltd (ASX: TLS) went ex-dividend this morning and have fallen by 11 cents at the time of writing – equal to the dividend payment.

However, the shares have fallen 30% since this time a year ago, and have almost halved in price in the last 3 years. Telstra used to be (and may still be) a favourite of investors who seek income due to the steady dividend payment, but is the company now of interest to value investors?

The current market capitalisation of Telstra is $41.5 billion, which puts it at a P/E of 11.2 at the current price of $3.38. The average P/E ratio for Telstra over the 10 years to June 30 has been 13.37.

As at June 30 2017, it held $0.94 billion in cash and equivalents, and $14.8 billion in interest bearing debt. This gives it an enterprise value of $55.36 billion at that time.

With the reported EBITDA of $10.97 billion, Telstra has an Enterprise Multiple of 5.03. Generally, anything under 7.5 is considered cheap. However, depreciation is a significant cost given the company’s assets. EBIT for the 12 months to June 30 was $6.53 billion, given it an enterprise value to EBIT ratio of 8.47.

Its Acquirers’ Multiple (Enterprise Value/Net operating cash flow) is 7.1. I am comfortable buying strong companies anywhere under 10.

Lastly, Telstra has a Sonkin Ratio (a tax-adjusted enterprise multiple) of just over 12, which means you are paying $12 for every dollar of after tax earnings. This is the 16th cheapest on the ASX200.

Therefore, Telstra is ‘cheap’ at today’s price. However, before investing you must consider whether it’s a value trap – is the company so bad that it is on a one-way slide downward? After all, Warren Buffett’s rule number 1 is ‘Don’t lose money’.

The company has a lot of assets and has made some investments in its future. The dividend payout ratio has also been above 90%, and although it wouldn’t be popular the company can decrease its payout ratio and reinvest in the business. There is already some evidence of this.

While the company holds a lot of debt and its debt to equity is higher than I would be comfortable with, its earnings are 100% cash. Cash interest cover is also acceptable.

Foolish takeaway

At the current share price, Telstra looks relatively cheap. Without knowing what will happen in the future, I believe the price that you’re paying for a business is of primary importance. The price at Telstra looks good, and I’d consider buying today.

Motley Fool contributor Stewart Vella has no position in any of the stocks mentioned. The Motley Fool Australia owns shares of and has recommended Telstra Limited. 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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