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Why Telstra Corporation Ltd is trading at 7-year lows

The share price of telecommunications company Telstra Corporation Ltd (ASX: TLS)  has fallen over 10% this week following the release of a disappointing trading update on Monday. The last time Telstra traded at its current price of $2.86 was in August 2011.

Weakness in mobile

A challenging trading environment has seen Telstra announce that its outlook for FY18 earnings before interest, tax, depreciation and amortisation (EBITDA) is now at the lower end of the $10.1-$10.6 billion range. The company also expects the difficult trading environment in mobile and fixed services to continue into FY19.

Despite increasing the number of postpaid handheld subscribers in Q3, postpaid handheld average revenue per user (ARPU) fell 3.6% to $65.35 on the prior correspond period. As a consequence, mobile EBITDA is now predicted to decline for FY18 against the prior corresponding period.

NBN earnings hole

Telstra’s traditional moat in fixed services has seen a significant erosion of earnings due to the National Broadband Network (NBN) rollout. Last August, Telstra announced its dividend will be reduced because of the estimated $3 billion per annum in earnings that will evaporate from the NBN rollout. At the end of the first half of FY18, Telstra had cumulatively absorbed $870 million of the $3 billion earnings hole.

Losing a large part of Telstra’s traditional earnings places greater importance on the company’s operations in the mobile space. During the first half of FY18, mobile EBITDA comprised 47% of the group’s recurring core EBITDA. Monday’s trading update showed declining ARPU and lower mobile EBITDA on the prior corresponding period. This is not particularly encouraging for Telstra given how important mobile earnings will be in plugging the NBN earnings hole.

The rising number of Mobile Virtual Network Operators such as Amaysim Australia Ltd (ASX: AYS) has added to the competitive pressure incumbents are facing in the mobile sector. Competition is also expected to intensify when TPG Telecom Ltd (ASX: TPM) becomes the 4th network operator in Australia.

Future dividends

Telstra has reaffirmed its FY18 ordinary and special dividend to be 22 cents per share which prices the stock at a high dividend yield of 7.7%. However, with competitive pressures affecting the company’s business, investors appear to be questioning the size of future dividends. Telstra’s capital management framework intends to pay fully-franked ordinary dividends of 70-90% of underlying earnings.

Investors will now have to wait until June for a further market update regarding additional strategies Telstra’s management intends to implement to address the competitive pressures facing the business.

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Motley Fool contributor Tim Katavic has no financial interest in any company mentioned. 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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