Could the stage now be set for Telstra shares to outperform?

"Accelerating cash flows" could help boost telco returns in the coming period.

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Key points

  • The telco sector has been a defensive refuge during 2022’s volatility
  • Telstra expects to grow its earnings and dividends in the next few years
  • Morgan Stanley thinks that telcos are likely to generate higher cash flow, leading to increased shareholder returns

The Telstra Corporation Ltd (ASX: TLS) share price has managed to provide stability compared to other sectors during the volatility of 2022.

For example, while Telstra shares are down 6% for 2022 to date, the Betashares Nasdaq 100 ETF (ASX: NDQ) – which is predominately invested in US tech shares – is down around 25%.

One of the attractions of Telstra may be that it receives regular cash flow from its household and business customers. The COVID-19 period and ongoing digitalisation of the economy are probably good indications of how integral an internet connection is these days.

But, past returns are old news. However, one expert thinks that telcos can keep performing well from here.

"Higher returns for longer" for telcos

According to investment bank Morgan Stanley, the telco sector has beaten the performance of global shares by more than 10% in 2022 to date. However, could this outperformance mean that the defensive play of investing in the telco sector is over?

Not so, according to Morgan Stanley's Emmet Kelly, head of telecom research at the investment bank. Kelly said the following, not specifically about Telstra, but on the telco sector:

Telecoms are trading about 30% cheaper than other defensive stocks, which is a 15-year low. This leads us to think the outperformance is set to continue.

A key part of Morgan Stanley's thinking is that telco spending on infrastructure may decrease, meaning they will have more "financial flexibility" and that stronger cash flow will enable telcos to carry out "buybacks and shareholder dividends."

Telstra forecasts lower costs and higher profit

As part of its T25 strategy, Telstra has said it is planning to reduce its fixed costs by $500 million between FY23 to FY25. It's also hoping to grow its underlying earnings per share (EPS) at a compound annual growth rate (CAGR) in the "high-teens" to FY25.

Over the next few years, it's planning to extend 5G network coverage to 95% of the population. By FY25, it's expecting 80% of all mobile traffic to be on 5G.

Telstra also said that it's seeking to grow its dividends over time whilst also investing for growth. The final dividend of FY22 was an increase from 8 cents per share to 8.5 cents per share.

Is the Telstra share price an opportunity?

Morgan Stanley does have an overweight rating on the telco at the moment, which is equivalent to a buy.

The price target is $4.60, implying a mid-teen rise for Telstra shares over the next year, on top of the dividend return. Morgan Stanley has also suggested the recent cyber hack at Optus could lead to subscribers jumping ship to Telstra.

At the current Telstra share price, it could have a grossed-up dividend yield of 6.1% in FY 23 according to the broker.

Motley Fool contributor Tristan Harrison has no position in any of the stocks mentioned. The Motley Fool Australia's parent company Motley Fool Holdings Inc. has positions in and has recommended BETANASDAQ ETF UNITS. The Motley Fool Australia has positions in and has recommended BETANASDAQ ETF UNITS and Telstra Corporation Limited. 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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