Why I think Telstra Corporation Ltd is getting close to a buy

Credit: Telstra

An old-time dividend play, Telstra Corporation Ltd (ASX: TLS), is trading at a price of $3.06, at the time of writing, down nearly 40% in three years and close to a seven-year low.

Does Telstra deserve another look at this price?  

Investors holding Telstra for the fully franked trailing dividend yield per annum may find it difficult to sell. But holding for the yield could result in a significant capital loss given the impact of (Labour’s) potential changes to claiming franking credits. 

To be considered a buy for dividends, a company must pass a few hurdles: 

  • Dividend yield: Telstra’s trailing yield is high and a sign that all is not well. A high yield alone is not a buy signal, as it can also mean a weak share price due to an uncertain earnings outlook.  
  • Dividend sustainability: Telstra has cut dividends by reducing the payout ratio from 100% of earnings to 70-90% of earnings. There may be further cuts when the extent of the impact of the NBN becomes more apparent. There is the prospect of a $0.22 dividend this year (Telstra has already paid $0.11 a share for FY18) down from $0.31 in 2017.  But, on the other hand, Telstra may be congratulated for cutting dividends to reinvest in the business to improve the earnings outlook, which may support a recovery in dividends over time. High payout ratios can mean that potential earnings growth is not being tapped by not reinvesting in the business to grow earnings. Dividend coverage is good at 1.21x. 
  • Future earnings growth: Telstra is trading on a forward PE ratio of 10.09 with JB Were forecasting earnings per share (EPS) of $0.297, down from an EPS $0.338 in FY17. As such investors are not expecting any growth.

Telstra is failing nearly every hurdle to be judged a “safe” dividend play, but watch this space as the forecast dividend yield of more than 7% is still attractive, and is likely to be paid at least over the next few years.

As well as cost cutting, Telstra is getting close to being a buy again, although it carries plenty of risk if it cannot stabile itself.

TPG Telecom Ltd (ASX: TPM) Australia’s second-largest telecommunication company by market cap has fallen over 15% in one year to $5.24. It has a positive outlook for earnings but does not pay a meaningful dividend.

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Motley Fool contributor Rosemary Steinfort owns shares in Telstra. The Motley Fool Australia owns shares of and has recommended Telstra Limited and TPG Telecom 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 Scott Phillips.

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