Since September 9, the S&P/ASX 200 Index (INDEXASX: XJO) has fallen 4.96%, and since hitting a 12-month high of $5.76 in late August, shares in Telstra Corporation Ltd (ASX: TLS) have slumped 6.4% to last close at $5.39.
Some have blamed the Aussie dollar due to exchange rate losses incurred by overseas investors who may be selling. However, they don't have Australian shareholders' tax incentive of fully franked dividends. The current yield on Telstra shares is 5.47%, but when grossed up for franking (by dividing by 0.7) the yield becomes 7.8%. The central question for both existing and potential shareholders is….
Is the Telstra dividend sustainable?
Before considering the Telstra dividend, let's ponder the general warning signs for unsustainable dividends including:
- A high yield may be deceptive because the share price of a company may fall in anticipation of a reduced dividend.
- A high dividend yield may be the result of a high payout ratio, which may indicate less is being reinvested into the business and may make the dividend unsustainable.
The case for and against a sustainable dividend for Telstra:
- Management may be intending to make a large acquisition. However, there is recent evidence of the company preserving cash by avoiding large capital expenditures, for example the recently announced strategy of co-investing alongside Asian telecommunication companies to build 4G networks.
- Uncertain future NBN cash flows as renegotiations are yet to be finalised. The recent $1 billion buy-back would suggest management is very confident of future cash flows.
- Slower-than-expected growth rates in mobile services or just a negative outlook statement for mobile growth. There is little evidence of this to date and it may be countered to some extent by increased fixed-line profitability. This would result from a slowing of the decline in fixed-lines and a reduction in churn rates.
Your investment today could potentially double in less than 10 years.
A dividend yield of only 7.2% per annum is required to double your investment in 10 years. This falls to 7.2 years if the average annual return is 10%. Some confidence may be derived from consensus grossed up dividend yield forecasts for FY2015 and FY2016 of 8.14% and 8.7% respectively.
