Are Telstra shares now a brilliant bargain?

Telstra is optimising its costs for future profit growth.

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The Telstra Group Ltd (ASX: TLS) share price has been sluggish over the past year, falling by 20%. This leading telco stock has underperformed the S&P/ASX 200 Index (ASX: XJO), which is up 7% during the same period. At the time of writing, the Telstra share price is trading at $3.48.

Telstra offers a dividend yield of 5.03%, surpassing the Reserve Bank of Australia's official cash rate of 4.35%. Can this be a good investment opportunity for dividend-focused investors? 

Telstra's valuation has become cheaper

The declining share price has made Telstra cheaper in terms of the price-to-earnings ratio. According to S&P Cap IQ, the Telstra share price is now valued at 19x FY24's estimated earnings, down from 24x a year ago and near the midpoint of its historical trading range of 10x to 28x. 

Telstra generates a robust operating cash flow of approximately $7 billion annually, supporting its substantial cash dividend payments. As mentioned above, Telstra offers a fully-franked dividend yield of 5% at the current price.

How about Telstra's business outlook?  

The telecommunications industry necessitates continuous investment in capital assets to ensure a high quality of service. Telstra spends nearly $4 billion annually on capital expenditures (capex), leaving approximately $3 billion of free cash flow, which is the cash left after accounting for cash outflows to support operations and capex.

While Telstra's free cash flow of $3 billion is sufficient to cover its current annual dividend payments of $2.3 billion, future earnings growth is crucial for raising its dividend payments. 

Unfortunately, Telstra faces growing competition from more affordable alternatives, driven by consumer efforts to manage living costs. Additionally, as the largest player in the Australian market, Telstra has limited domestic growth opportunities. 

With that said, Telstra is proactively finding ways to optimise its cost structure, as highlighted in its recent market update in May 2024

Foolish Takeaway

The Telstra share price has been disappointing this year. However, the company's valuation has become more attractive, trading at 19 times, and it offers a dividend yield of 5%. 

With limited revenue growth opportunities, Telstra's focus on cost optimisation is a promising strategy for enhancing net profits and sustaining future dividend payments.

The execution of Telstra's cost optimisation and growth strategies will be critical going forward.

Motley Fool contributor Kate Lee 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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