It sounds preposterous, but investors could soon be asking if a dividend upgrade is in the wings for the Telstra Corporation Ltd (ASX: TLS) share price.
It was only as recent as the February reporting season when the market was bracing for a dividend cut from our largest telco.
There was a palpable sense of relief when Telstra didn’t cut its interim dividend any further. It paid a 5-cents a share regular dividend and topped it up with a 3-cents a share payment, just as it did in 2020.
Telstra’s profit and dividend outlook improving
But two months is a long time on the ASX. The multiple headwinds that forced Telstra to lower its dividend in 2018 appear to be abating.
This prompted UBS to speculate if the telco could be flushed with excess cash over the medium term.
There are a few bright spots that support this bullish thesis. The intense competition for mobile subscribers appears to be easing. We aren’t seeing the same widespread price cuts on mobile plans as before.
NBN and other new opportunities
Secondly, the earnings threat from the NBN has also passed what I call “peak pain”. UBS also pointed out that cost pressures from migrating customers to the NBN is easing.
Throw in the recovery from COVID-19 disruptions, opportunities from 5G and NBN-alternative service offerings and cost reduction programs, and you have a more bullish outlook for cash flow.
These drivers aren’t unique to the Telstra share price of course. The TPG Telecom Ltd (ASX: TPG) share price is also well placed to benefit.
Improving cash flows and dividends payouts
“We take this a step further and investigate the cash flow profiles for TLS & TPG over the medium term,” added UBS.
“Following spectrum auctions this year & investments in 5G network upgrades over the next ~2 years, we see potentially ~6 years of sustained FCFs [free cash flows] that are significantly above earnings from FY23E in the absence of growth investment opportunities.”
Based on the broker’s estimates, Telstra could be sitting on a circa $5 billion cash pile. Meanwhile, TPG could have around $3 billion, of which a third is derived from its tax asset.
Why Telstra’s dividend may not increase for years
But this does not necessarily mean Telstra is about to lift its dividend. UBS thinks it’s a bad idea for Telstra to link its dividend to FCFs.
This is because there is uncertainty over how much Telstra will need to pay for spectrum in the coming years. Telstra is also unlikely to have sufficient franking credits to cover a material increase in dividends.
However, Telstra could use the excess cash on other capital management initiatives, like share buybacks.
TPG’s dividends set to grow
UBS is forecasting Telstra’s dividend to remain steady at 16 cents a share till FY25, when this is increased to 17 cents.
If you want a dividend upgrade sooner, you might have to choose the TPG share price. UBS believes TPG will increase its full year payout to 17.5 cents this financial year from the 7.5 cents it paid in FY20.
UBS is recommending both ASX shares as “buy” but prefers TPG.
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The Motley Fool Australia owns shares of and has recommended Telstra Limited. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.
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