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Telstra – Cash cow

The cash keeps rolling in at Telstra so the investment question is how and when will the company pay it out to shareholders?

The good news is that shareholders are already enjoying the fruits of a robust business model underpinned by its strength in mobile and broadband. A slowing rate of demise of the legacy fixed line earnings also helps the broader case for owning Telstra.

 

The company is gradually coming out of its shell and making investments such as Pacnet (US$697m) and various e-Health businesses that will prepare it for future growth leveraging its core infrastructure.

 

So, with $3.3 billion of excess free cash flow, the steady interim dividend of 15cps may have disappointed some people, but the bigger picture is relevant here.

 

Telstra’s capital management strategy is to increase the dividend over time but that will depend on a number of factors such as franking credit availability, investment requirements and steadily increasing operating cash flow.

 

A further factor to watch closely is the gradually increasing volume of payments from the NBN which CEO David Thodey currently describes as ‘early stages’. As those payments swell, so will Telstra’s cash flow providing yet more room for the Board to manoeuvre on capital management.

 

Full year guidance was unchanged at $4.6-$5.1 billion of free cash flow so it is not unreasonable to think the final dividend will get a small boost. The dividend reinvestment plan has been reinstated and will apply to the final dividend for 2015, probably without a discount.

 

Telstra clearly enjoyed massive interest in the new Apple iPhone products with handset sales surging from $709m in the second half of FY14 to $947m in the current half year result, a lift of $238m sequentially. Many of these phones were ‘funded’ by the company by signing up customers on 2-year contracts. In total, Telstra added 366,000 new mobile retail customers during the period.

 

Worth noting is the number of 4G customers has now surpassed the number of 3G customers on the network and this partly explains why the volume of data being used is also surging.

 

Adding to the mix is the increase in average revenue per user which is a shade under $70 per month for customers on postpaid contracts.

 

Market share may have taken a small dent as Optus and Vodafone tried to offer more competitive packages. Telstra needs to be careful not to engage in a full scale price war that would damage margins but it must also not repeat the mistakes of the Trujillo era when the company believed its network was superior enough to sustain premium prices.

 

There’s not much to lose sleep over for Telstra investors. The net yield story at 4.6% is identical to CBA and this is clearly sustaining an appetite for the stock, and like CBA, TLS has a good underlying business story to support it.

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