UBS weighs in on how much Telstra (ASX:TLS) will have to cut its dividend

Investors in Telstra Corporation Ltd (ASX: TLS) have been grappling with some pretty bad news of late and one factor clouding the outlook for suffering shareholders is how much the beleaguered telco will have to cut its dividend.

Brokers have been grappling with the question of late – with most saying the telco’s commitment to a 22 cents per share payout is at risk, but there are differing views on just how much Telstra would have to chop.

UBS is the latest broker to weigh into the debate, saying the answer hinges on whether Telstra can limit its credit ratings downside and whether the telco announces any initiatives at its upcoming June strategy day.

“On the former, we no longer think TLS can support its ‘A’ credit rating, with a potential downgrade to ‘A-‘ (and even ‘BBB+’ long term) increasingly likely,” it said in a report.

“Nevertheless assuming TLS acts to limit credit rating downside, progressive dividend cuts from FY20 are potentially required.”

It added that Telstra is likely to cut its dividend in order to soften any credit ratings downgrades, noting that historically, a 1.5 – 2.0x debt to earnings before interest, tax, depreciation and amortisation (EBITDA) ratio was sufficient for the telco based on its “strong” business profile.

However, it says with factors such as competitors narrowing the mobile network gap (plus a 4th entrant), a stronger financial profile is arguably required relative to history but Telstra is on track to see its adjusted debt to EBITDA rise to ~2.2x in FY20 / FY21 on a 22cps dividend.

“Cutting DPS is one solution: but a progressive cut to ~14cps is necessary for leverage to fall below 2.0x by FY22E,” it said in a report.

UBS is forecasting Telstra’s FY2018-2019 dividend to remain at 22 cents per share, a cut to 18 cents per share in FY2020 and a cut to 14 cents per share in FY2021-2022, with its forecasts subject to any initiatives the company announces at the upcoming strategy day.

The broker adds that it believes that Telstra will outline strategies at the June investor day, such as productivity and cost-out initiatives which could protect a 22 cents per share dividend in FY2019 and soften a dividend cut in FY2020.

The broker also cut its target price to $2.80 from $3.10 and has a “Neutral” rating on Telstra.

Telstra is currently on a dividend yield of 8.4% compared to 5.8% for Australia and New Zealand Banking Group (ASX: ANZ), 6.1% for Commonwealth Bank of Australia (ASX: CBA), 7.3% for National Australia Bank Ltd. (ASX: NAB) and 6.6% for Westpac Banking Corp (ASX: WBC).

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Motley Fool contributor Gabriella Hold has no position in any of the stocks mentioned. The Motley Fool Australia owns shares of and has recommended Telstra Limited. The Motley Fool Australia owns shares of National Australia Bank 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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