Payment of high dividends has been a recurrent theme in recent reporting seasons, and they were prominent again in February.
We’ve been monitoring the sustainability of dividend payments and found the earnings report delivered by Telstra Corporation interesting.
Chart 1 shows our earnings estimates for Telstra’s underlying business as it is today. We have split the National Broadband Network (NBN) component of earnings into two parts – recurring earnings (orange bars), and one-off compensation payments from the government that are received by Telstra during the NBN build and then cease (grey bars).
The chart shows that earnings remain intact out to FY19 but then a clear downward trend emerges in Telstra’s underlying earnings out to FY21. This reflects a fall in Telstra’s margins as the NBN makes the market more competitive. The yellow line on the chart is Telstra’s free cash flow (after deducting dividend payments, capex, tax and interest), which turns sharply negative in FY20 and FY21 when the one-off NBN payments cease.
Faced with a negative free cash flow position, Telstra would have two choices: either borrow to maintain its dividend payments or reduce its dividends significantly. For example, in FY21 Telstra would have to either borrow $1.5b to maintain its estimated $3.7b dividend or cut its dividend payments by around one third.
So, our numbers suggest Telstra’s dividends are not sustainable longer term. The market isn’t yet focused on this issue as it is several years away, but we think it eventually will.
Chart 1: Telstra Corporation – earnings* estimates and free cash flow
Source: Antares, March 2017.
* Earnings before interest, tax, depreciation and amortisation.
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