Income Report / Income Note: Why we think Telstra’s dividend is sustainable (SUL, RIO, TLS)

By Market Matters 09 September 20

Income Note: Why we think Telstra’s dividend is sustainable (SUL, RIO, TLS)

Market Matters Income Report 9th September 2020

The market is getting hit hard today thanks to weakness in the US overnight largely predicated on a large move out of the ‘tech titans. As we suggested this morning, the market locally remains in the 5700/6200 trading that it’s been oscillating in for a few months – in other words, we remain relaxed at least for now running with the mantra of buying weakness / selling strength while the market remains within the range, however as always we’ll remain open-minded and vigilant.

Looking at sectors today, not much love anywhere although energy the clear laggard.

Sectors today

Source: Bloomberg

Overall, the ASX 200 is currently trading down -150pts/-2.49% to 5858.

ASX 200 Chart

The Income Portfolio fell marginally last week down by -0.08%. A number of positions went ex-dividend including AMPPB, NABPF, CBAPG, BHP, PPT, MXT. The portfolio is up +3.85% FY21 to date with the benchmark (RBA + 4%) sitting at 0.80%.

Super Retail Group (SUL) $10.25: This week we took a nice 78% profit in Super Retail (SUL) following its strong FY20 results and upbeat commentary on its start to FY21. The market has become bullish on retailers and in the case of SUL, are forecasting profit growth in FY21 of 10%, extrapolating a strong first 2 months further out. Funnily enough, my wife emailed me this week suggesting we need a new tent given we’ve got 3 camping trips planned leading into and after Christmas having just cancelled a trip to QLD in October. This is exactly what’s driven sales in brands like BCF which are up more than 70% on last year. In any case, the stock has run exceptionally hard and is no longer cheap even if elevated market expectations are met.

We think MM got the chunk of the move in SUL and we’ve used the proceeds to buy Telstra (TLS) into recent weakness, a stock we’ll cover today.

Super Retail Group (SUL) Chart

Other stocks in the cross hairs: In the MM Growth Portfolio we cut Rio Tinto (RIO) at $103 a few weeks ago, however we held in the income portfolio for yield. The stock has pulled back to $99 and looks positive for another assault at the $105 region at which point we’ll be likely sellers as we look to reduce exposure to Iron Ore into strength.

Rio Tinto (RIO) Chart

Why Telstra’s dividend is sustainable?

We added Telstra (TLS) to the Income Portfolio this week and wanted to provide some more detail around the sustainability of the dividend in the first instance, then the scope for improvement in the share price thereafter.

TLS reported FY20 earnings mid-August, they met expectations for the current year however they poured cold water over earnings guidance for FY21. They maintained the dividend at 16c; however this is made up of 10c ordinary and a 6c special which is related to NBN payments. The concern is that the ‘real’ dividend will be closer to 10c than 16c however in MM’s view that’s unlikely.

If we’re right, TLS paying 16c into the future has it on an attractive yield of 5.5% plus franking.

On an earnings basis, the 16c dividend is not sustainable given TLS will likely generate around 14c EPS in FY21 & FY22 before rising from there, however TLS have shifted their dividend focus to be more heavily aligned with free-cashflow (FCF).

In terms of that number, which seems to now be the key for the dividend, it’s expected to be 20c in FY21, 21c in FY22 and rising from there.

What is free cash flow? Free cash flow (FCF) represents the cash a company generates after accounting for cash outflows to support operations and maintain its capital assets. Unlike earnings or net income, free cash flow is a measure of profitability that excludes the non-cash expenses of the income statement and includes spending on equipment and assets as well as changes in working capital from the balance sheet.

Given the rhetoric around free-cash-flow that we saw at the recent result, it seems likely that the market is too bearish on the sustainability of the TLS dividend given its being anchored to EPS, not FCF. While earnings are under some pressure, they are expected to improve over the coming years (I know I know – it’s been like this for ever), however worth bearing in mind that TLS have made some tough decisions in recent times to get the business on a better footing to deliver that much anticipated growth.

In broad terms, a sustainable dividend we think is enough to support the share price up to about a 4.5% yield which equates to a SP around $3.50, then if earnings can show some growth, we think there is a very plausible path for TLS to trade back up towards $4.00.

MM is bullish Telstra (TLS) for income

Telstra (TLS) Chart

Conclusion (s)

MM is looking to sell RIO into strength

We are confident in the sustainability of Telstra’s yield

Have a great day!

James, Harry & the Market Matters Team

Disclosure

Market Matters may hold stocks mentioned in this report. Subscribers can view a full list of holdings on the website by clicking here. Positions are updated each Friday, or after the session when positions are traded.

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