The Telstra Corporation Ltd (ASX: TLS) share price tumbled to a three-month low on Monday after the stock was downgraded by a leading broker.
Shares in Australia’s largest telco fell 1.9% to $3.05 when the S&P/ASX 200 Index (Index:^AXJO) declined 0.8% today.
If it’s any consolation to shareholders, Telstra’s peers also finished in the red. The TPG Telecom Ltd (ASX: TPG) share price slipped 1.2% to $7.36 while the Vocus Group Ltd (ASX: VOC) share price gave up 1% to $2.92.
Broker downgrade weighs down TLS share price
Telstra was the laggard as it was weighed down by JPMorgan’s downgrade. It cut its recommendation on the stock to “neutral” from “overweight”.
The move comes after the company posted Telstra’s disappointing FY20 profit results last week, which prompted the broker to cut its earnings forecast for the group.
“Our initial review has highlighted a number of significant structural challenges facing the company,” said the broker. “Furthermore, an estimated 4.2% dividend yield is not overly compelling.”
Structural headwinds
One of these structural challenges include the impact of the NBN eroding profit margins on Telstra’s fixed broadband business.
Rising competition on Telstra’s mobile division is cited as another headwind, while the COVID-19 travel restrictions have decimated its mobile roaming revenue.
Mobile is a key earnings driver for Telstra, which tried to lift prices on its mobile plan recently. That backfired as competitors doubled down on low prices to win market share from the market leader.
Telstra’s dividend is unsustainable on payout guidance
What is concerning for shareholders is the dividend. JPMorgan is forecasting a cut in the group’s annual payment to 13 cents a share from 16 cents.
That’s below consensus with the average broker estimate tipping a 14 cents a share payout. But JPMorgan believes 13 cents is all Telstra can afford. This is because that would represent 90% of Telstra’s forecast net profit – which is the top end of Telstra’s payout ratio.
“While Telstra does not provide dividend guidance, it indicated at the result that EBITDA would need to be ~A$7.5-$8.5 billion to maintain its 16cps dividend, well above guidance of A$6.7 billion,” added JPMorgan.
How Telstra can keep paying a 16cps dividend in FY21
However, not every broker agrees with this. Goldman Sachs believes Telstra could keep paying 16 cents as management may not strictly apply its payout ratio policy.
“Although 16cps is now unsustainable across FY21-22 on the existing payout policy, we note TLS further shifted its dividend focus to FCF [free cash flow] (i.e. TLS justified the 99%, out-of-policy EPS payout as this was well supported by cashflow),” said Goldman.
“Hence, we have not revised our 16c dps, believing Telstra will maintain this through FCF, if it believes that is on track for $7.5bn by FY23E.”
Goldman stuck to its “buy” recommendation on the stock, which is also on its “conviction list”. The broker’s 12-month price target on Telstra is $3.90 while JPMorgan’s target price is $3.40 a share.
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Motley Fool contributor Brendon Lau owns shares of Telstra Limited. Connect with him on Twitter @brenlau.
The Motley Fool Australia owns shares of and has recommended Telstra Limited. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. 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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