With the Telstra share price plumbing new lows, are they now cheap enough to consider buying? They are pretty close

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With the Telstra (ASX:TLS) share price hitting an almost 8 year low yesterday, it’s clear many investors have given up on one of the ASX’s most popular stocks.

Long feted for its fully franked dividend, with some brokers now saying Telstra should cut its full year dividend to 14 cents, investor’s love affair is now well and truly over.

Yesterday, Telstra shares closed at $2.66, a 52-week low, and its lowest closing price since September 2010.

Source: The Capital Club

If you assume Telstra does cut its future dividend to 14 cents, the shares currently trade on a forecast fully franked dividend yield of 5.3 per cent, or 7.5 per cent when grossed up for franking credits.

From an income perspective, that’s a decent return. And don’t forget, Telstra have committed to paying a FY18 final dividend of 11 cents per share, likely to be paid to shareholders towards the end of September.

But with Telstra shares already down 38 per cent in the last 12 months, it’s the potential for future capital loss that’s the bigger concern.

Value in Telstra shares

Earlier this month, but before Telstra’s recent strategy day, where the telco lowered its FY19 earnings guidance, the Pengana Australian Equities Fund said that despite near term headwinds, it thinks there is value in Telstra shares.

The fund said that after a period of rebasing, Telstra should be able to leverage its superior network and 5G offering to stabilise and even modestly grow earnings.

The period of financial rebasing is well and truly here. Earnings are falling, forcing Telstra to drastically reduce its cost base, with 8,000 jobs to go in the next three years.

But the company is also rebasing its product offerings, simplifying and reducing them to just 20 core plans.

Telstra shares — cheap and with an attractive dividend yield

At the midpoint, Telstra expects FY19 EBITDA to be around $9 billion, which translates to earnings per share around 27 cents per share.

With Telstra shares trading at $2.66, that has the shares trading on a forward P/E ratio of around 10 times earnings.

Telstra’s dividend policy is to pay a fully franked ordinary dividend of 70 to 90 per cent of underlying earnings, and return in the order of 75 per cent of net one-off nbn receipts over time via fully franked special dividends.

That suggests the Telstra dividend in FY19 will be around 21.5 cents, meaning Telstra shares today trade on a forecast fully franked dividend yield of 8.1 per cent, or 11.5 per cent when grossed up for franking credits.

Even if you assume Telstra’s FY19 dividend is 20 cents, the current forecast fully franked dividend yield is 7.5 per cent, or 10.7 gross.

It should go without saying that these are only estimates. It’s a brave new world for Telstra, and earnings could fall even further, taking the dividend down with it.

Once upon a time, when interest rates were higher, you’d buy a share for capital growth, the dividend being somewhat secondary.

Telstra’s revenue is falling. From its new, lower base, future revenue growth is unlikely to be exciting, given most of the population already have mobile phones and internet.

Why Telstra shares are pretty close to a buy

At some stage, if Telstra shares continue to fall, they become attractive. As Pengana says, Telstra still has the superior network, and 5G will be here relatively soon.

At what price do Telstra shares become a buy?

At $2.66, they are pretty close now, trading as they are on an earnings yield of around 10 per cent and a gross dividend yield of around 10 per cent.

From here, over the next 12 months, I wouldn’t be surprised if Telstra shares total return, including dividends, was around 15 per cent.

Contributors to this article may own shares in some of the companies mentioned in this article. The Capital Club has a thorough disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.
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Bruce Jackson has 30 years of hands on investing experience. He is passionate about stock market investing, running his own portfolio and SMSF. His focus is on small cap growth stocks. You can contact Bruce at brucej@thecapitalclub.com.au