Telstra share price is 'undervalued' right now: broker

Is this telco giant undervalued?

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The Telstra Group Ltd (ASX: TLS) share price has been reasonably subdued over the last 12 months.

As you can see on the chart below, the telco giant's shares are trading largely in line with where they were a year ago.

Is the Telstra share price undervalued?

Firstly, while investors like to use earnings per share or price to earnings multiples to value a share, this would be a mistake with the Telstra share price.

That's because Telstra's free cash flow has been and is expected to remain higher than its net profit. As a result, its earnings per share metric doesn't accurately represent its financial performance.

For example, in FY 2022, Telstra reported net profit after tax of $1.8 billion but free cash flow of $4 billion.

Based on Telstra's outstanding shares, this means that Telstra generated earnings per share of 15.3 cents in FY 2022.

As a result, on paper this makes it look like the Telstra share price is trading at 27x trailing earnings, which is reasonably expensive. However, on a free cash flow basis, the multiples it trades on are significantly lower.

What is Morgans saying?

According to a note out of Morgans, its analysts estimate that Telstra generated free cash flow (after lease payments) per share of 26 cents in FY 2022.

And while the broker expects Telstra's free cash flow per share to fall to 20.8 cents in FY 2023, it believes it will still be 22% higher than the company's earnings per share of 17 cents.

In light of this, it makes more sense to value Telstra's shares on its free cash flow rather than its earnings.

Together with its belief that potential divestments could unlock value, this explains why Morgans thinks the Telstra share price is undervalued at the current level. It commented:

After a major turnaround, TLS has emerged in good shape with strong earnings momentum and a strong balance sheet. In late CY22 shareholders vote on Telstra's legal restructure, which opens the door for value to be released. TLS currently trades on ~7x EV/EBITDA. However some of TLS's high quality long life assets like InfraCo are worth substantially more, in our view. We don't think this is in the price so see it as value generating for TLS shareholders. This, free option, combined with likely reputational damage to its closest peer, following a major cybersecurity incident, means TLS looks well placed for the year ahead.

Morgans has an add rating and $4.60 price target on Telstra's shares. It is also expecting a 4% fully franked dividend yield in FY 2023.

Motley Fool contributor James Mickleboro has no position in any of the stocks mentioned. The Motley Fool Australia's parent company Motley Fool Holdings Inc. has no position in any of the stocks mentioned. The Motley Fool Australia has positions in and has recommended Telstra Group. 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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