The Telstra Corporation Ltd (ASX: TLS) share price is going to be on watch this reporting season.
The telco is an interesting one. Its report is highly anticipated with everything that's going on with COVID-19 at the moment.
There are some ASX blue chips that are likely to reveal a substantial profit hit because of COVID-19 like Commonwealth Bank of Australia (ASX: CBA). Whereas others like Wesfarmers Ltd (ASX: WES) seem to have had a strong year. Where will Telstra fall on this scale?
Telstra's FY20 guidance
Before COVID-19, the company was expecting underlying earnings before interest, tax, depreciation and amortisation (EBITDA) to be in the range of $7.4 billion to $7.9 billion.
In Telstra's guidance update during the early part of COVID-19, it said it's expecting both free cash flow and underlying EBITDA to be at the bottom end of its guidance. It's also expecting its underlying EBITDA (excluding the in year NBN headwind) to be at the bottom end of its growth range of $0 to $500 million.
Whilst a reduction of profit expectations is not good news, I think that underlying profit being flat would be a good result considering all of the difficulties that Telstra has suffered this year.
Despite the profit difficulties, Telstra is expecting its capital expenditure to be at the top end of its guidance. The company is investing heavily in its new 5G network which will support the next generation of devices which will have very fast operating capabilities.
Where is the profit growth going to come from?
I think the only way for a business to deliver a sustainable increase in valuation is to increase the profit. The Telstra share price hasn't done much over the past three years.
In the FY20 half-year result it reported good growth in customer numbers, particularly with the mobile division. During the half year it added 137,000 retail postpaid mobile services (including 91,000 customers from Belong) 135,000 retail prepaid mobile services and 173,000 pre and postpaid and IoT wholesale services.
Adding new customers is essential for Telstra to maintain (let alone grow) its profit. The NBN is hurting Telstra's profit due to the lower profit margin for each customer. Telstra used to own the cable infrastructure and earn a higher return.
5G services will hopefully add a lot more devices for Telstra's network. Services like automated cars, wearables and so on will need a data connection to operate efficiently.
5G will need to be successful at attracting new customers if Telstra's share price and earnings are going to rise from here. More 5G-capable devices are regularly being released by suppliers like Samsung and Apple, which will add to Telstra's revenue base.
I think 5G could be a turning point for Telstra's home internet customers too. 5G may be so fast that customers made decide to switch from the NBN to 5G-enabled wireless internet. That wouldn't be so good for the NBN's earnings, but Telstra could benefit if its speeds and capacity are up to the challenge.
What about the Telstra dividend?
There has been a clear decline of the Telstra annual dividend over the past few years. It's now paying an annual dividend of 16 cents per share, which includes the special dividends relating to the NBN payouts.
At the current Telstra share price it offers a grossed-up dividend yield of 6.75%. That's not bad in this era of low interest rates. But I think income investors can do better than Telstra shares – either with better income growth or a higher starting yield. I don't think the Telstra dividend is going to change over the next couple of years. For that reason I'd rather buy something like Future Generation Investment Company Ltd (ASX: FGX) or Vitalharvest Freehold Trust (ASX: VTH).
