Is the Telstra Corporation Ltd (ASX: TLS) undervalued at today’s share price? Here’s why I would buy Telstra: dividends and a 5G future.
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Is the Telstra Corporation Ltd (ASX: TLS) share price undervalued today?
At the time of writing, Telstra shares are going for $2.80. Last week’s bump which pushed the Telstra share price to $2.89 has evidently faded. At $2.80, Telstra shares are back near their 52-week low of $2.76 that the company made just 2 weeks ago. It’s been something of a fall from grace for the ASX telco.
Back in July and August, Telstra was trading around the $3.50 mark, not to mention the $3.94 52-week high we saw back in January. The levels we see today are even below the depths that Telstra shares saw during the March share market crash.
So are Telstra shares undervalued today? Or is the market onto something here?
Why Telstra shares have been tanking
We can trace Telstra’s share price decline back to the company’s FY2020 earnings report that was released back in mid-August. Although Telstra reported an earnings drop of 9.7% and income fell by 5.9%, the market was largely expecting those kinds of numbers. What really riled investors though, was the company’s guidance for FY2021. Telstra has a ‘payout ratio policy’ of 70-90% of earnings when it comes to its cherished dividend. In 2019 and 2020, Telstra has paid out 16 cents per share, fully franked, in dividends to investors. However, Telstra also told investors that it expects a ~$400 million hit to earnings in FY2021 as a result of the pandemic. If that eventuated, it would threaten the 16 cents per share dividend, as that would no longer comfortably fall into 70-90% of earnings.
Investors don’t normally buy Telstra shares for anything other than hefty dividend income. So it’s understandable why the Telstra share price fell 18% over the 2 months after the earnings report was released.
However, when Telstra recently held its annual general meeting, the company changed its tune somewhat. In acknowledging the importance of its dividend to shareholders, the Telstra chair told investors that the company was “prepared to temporarily exceed our capital management framework principle of paying an ordinary dividend of 70- 90% of underlying earnings to maintain a 16c dividend”. That sounds like a virtual guarantee that shareholders will be receiving 16 cents per share again in FY2021 to me.
Happy days… you would think anyway. Telstra shares indeed popped on this news (around 4%). But since then, the company has slid back to the levels we see today.
Is Telstra undervalued right now?
On current pricing, a 16 cents per share dividend gives Telstra both a trailing and forward dividend yield of 5.71%. That’s a whopping 8.16% grossed-up with Telstra’s full franking credits. Even if the Telstra share price goes nowhere over the next few years, that’s a pretty decent return just from dividends and franking credits (provided there are no dividend cuts of course). But given what the company has said about its dividend, I don’t think this is likely.
Further, I happen to think there are a few avenues for Telstra to increase its earnings outside the traditional fixed-line and mobile spheres over the next few years. Apple Inc. (NASDAQ: AAPL) has just released a new iPhone range – the first offering 5G connectivity. Since Telstra on-sells new phones, this is good news in my view. Telstra is also investing heavily in its own 5G network, which I think has a good chance of offering the best coverage in Australia. This could add to earnings growth down the road.
Overall, I do think the Telstra share price is undervalued today. The company seems to be priced for a low-growth future filled with dividend cuts, which I don’t think will come to pass. Thus, I would consider buying Telstra as a value share today, especially if an 8% dividend catches your eye.
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Motley Fool contributer Sebastian Bowen owns shares of Telstra Limited. The Motley Fool Australia’s parent company Motley Fool Holdings Inc. owns shares of and recommends Apple. The Motley Fool Australia owns shares of and has recommended Telstra Limited. The Motley Fool Australia has recommended Apple. 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.