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Telstra’s dividend may not be as safe from COVID-19 as you’d think

Talk that Telstra Corporation Ltd (ASX: TLS) dividend isn’t safe from the axe shows how deep the coronavirus recession is expected to run.

Our largest telco runs one of the most defensive businesses on the S&P/ASX 200 Index (Index:^AXJO) as consumers can’t live without their mobile phones and internet.

But this isn’t stopping UBS from forecasting a 12.5% cut to Telstra’s dividend, which could start this August when the company hands in its next set of profit results.

Dividend risks rising across the market

The warning comes at a time when investors are fretting about a new dividend threat in another favourite sector – the big banks.

News that New Zealand implemented an immediate ban on bank dividends caught investors off guard.

Shares in Commonwealth Bank of Australia (ASX: CBA), Westpac Banking Corp (ASX: WBC), Australia and New Zealand Banking Group (ASX: ANZ) and National Australia Banking Ltd. (ASX: NAB) came under pressure on Thursday.

Why Telstra’s dividend could be cut

But coming back to Telstra, UBS is forecasting annual dividends will drop to 14 cents a share from 16 cents a share.

“Whilst our long-term EPS forecasts are unchanged at ~18cps [cents per share], COVID-19 has escalated execution risks,” said the broker.

“In our view, the market appreciates the short-term risks i.e. international roaming, NAS/enterprise, slower cost-out impacts.

“What seems less well understood, is the impact that COVID-19 and a weaker macro outlook has on medium-term mobile ARPU [average revenue per user] growth aspirations.”

Earnings growth risk

Telstra needs the tailwind from the grown in its mobile business if it wants to see earnings before interest, tax, depreciation and amortisation (EBITDA) hit $8 billion and earning per share reach 18 cents by FY22 or FY23.

While investors largely regard the COVID-19 pandemic as a shorter-term issue, its impact to Telstra’s earnings will be felt over a much longer timeframe. There are a few reasons for this.

COVID-19 impact can last longer than the virus

Firstly, Telstra’s plan to charge extra for 5G from this July may not happen given the expected recession and mass job losses.

This also limits the telco’s ability to move mobile subscribers up to higher plans while the rising number of price-sensitive customers may even opt to migrate to cheaper service providers.

Additionally, the disruption to supply chains from the forced global shutdown to stem the spread of COVID-19 may delay the 5G uptake.

Foolish takeaway

If UBS is right (and this isn’t a consensus view), Telstra is trading on an unappealing yield of 4.4%. But this improves to 6.3% if franking is included.

Anything that can provide you a stable yield above 5% is attractive in my book. Whether you buy Telstra will depend on your ability to qualify for franking.

And in case you are wondering, UBS is recommending the stock as a “buy” with a price target of $3.70 a share.

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Motley Fool contributor Brendon Lau owns shares of Australia & New Zealand Banking Group Limited, Commonwealth Bank of Australia, Telstra Limited, and Westpac Banking. 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.