There's growing pressure on Telstra Corporation Ltd (ASX: TLS) to sacrifice its sacred cow – its big fat dividend – when it releases its full year results next month. It won't be an easy decision for Telstra's board as its yield is the primary reason why many superannuants and retail investors have faithfully been buying and holding the stock.
But Citigroup has joined other brokers in urging Australia's largest telco to cut its dividend due to the expected drop in profits as Telstra faces increasing competition for its mobile business and lower earnings due to the NBN.
The broker is expecting Telstra to cut its FY18 dividend to 25 cents a share from the 31 cents it paid in the previous financial year, according to an article in the Australian Financial Review.
However, that cut won't be enough and Citigroup warns that it won't be long before investors suffer a second dividend cut. The broker thinks management should actually slash the dividend by 45% to 17 cents to ensure the payout is on a much firmer footing.
According to Citigroup, lowering the dividend to 17 cents a share will peg its payout at the low point of the forecast earnings per share for Telstra and will give management leeway to undertake a share buyback with the excess funds. This will be more value accretive to shareholders over the longer term
If the broker is right, that could see Telstra's shares dive to around $3 from their current level of $4.32. This is based on my assumption that investors will need to see a yield of around 5.5%-5.8% to be enticed to buy the stock. On a fully franked basis, the gross yield would be around 8% and that's not a particularly high yield given that global interest rates are on the rise.
I don't think there is a better way to value Telstra than on yield given that its unlikely to be seen as a growth stock anytime soon given the multiple headwinds it is facing, including a potential disruption to its prized mobile business from TPG Telecom Ltd (ASX: TPM).
The uncertainty over Telstra's dividend will make the stock one of the most hotly watched companies during next month's reporting season where management will have to walk a tightrope of sounding upbeat about the telco's future, but not sounding too positive due to the risk of underdelivering in the next few periods.
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