Telstra posted an overall mixed first-half FY18 result, with an underlying net profit of $1.947bn versus our forecast of $1.973bn, and declared an interim dividend of $0.075 per share, along with a special dividend of $0.035 per share. Guidance for the full year was reiterated.
The highlight of the result was the net addition of 130,000 post-paid mobile subscribers in the half, a much better outcome than we had expected. The euphoria over this positive outcome, however, has overshadowed the particularly steep margin decline in the fixed broadband business, along with narrower margins in the network applications and services (NAS) and global connectivity businesses.
We still expect the NAS and global connectivity businesses to eventually get back up to percentage margins in the mid-teens and mid-20s in the medium term, respectively, but the surprisingly steep decline in margins in the fixed broadband business in the half – to 17.2% from 28.2% – has forced us to lower our forecast group operating earnings margin significantly in FY19–22.
In turn, this causes our expected payout ratio as a percentage of earnings to slightly exceed 100% in FY21–23. That said, we would not expect another dividend cut in the near future. We note also that declines in post-paid average revenue per user will likely accelerate due to increasing competition, which will exacerbate the problem.
We expect Telstra’s dominance in the local market to continue, but recent structural changes to the industry from the NBN and the entry of TPG Telecom (TPM, Lighten) as a fourth mobile operator could pressure growth and profitability in the near term. However, the current dividend yield of about 6.0% is attractive, especially when compared to other incumbent telecom operators. We maintain our Hold recommendation on Telstra, but have cut our target price to $3.70 from $3.85.