Beware the dividend honeypot—the lesson of Telstra

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Shareholders burnt by Telstra’s dividend cut and spiralling share price should be wary of high yield shares with attractive dividends but shaky fundamentals. Telstra sparked an exodus of investors after announcing a cut in its dividend from 15.5c per share to 11c, with the challenges facing Australia’s major telco suddenly made palpable to mum and dad investors.

The lesson of Telstra is that investors should not invest purely for income or tax advantages (i.e. franking credits) at the expense of sound fundamentals. Despite being stuck in a downward trend since mid-2015, investors tolerated the stock’s poor performance so long as it maintained its attractive fully franked dividend.
 

The dividend cliff (TLS dividend $ per share)
* Expected
Source: Lonsec, Bloomberg, Telstra

 
The problem is that by the time a company is forced to cut its dividend, fundamentals have already deteriorated. In other words, investors waiting for the dividend cut as a signal to bail were already too late. While Telstra has confirmed a semi-annual dividend of 11c, FY19 guidance is vague, stating it will pay a dividend in the range of 70 to 90% of underlying earnings.
 

Telstra share price and P/E ratio

Source: Lonsec, Bloomberg

 

Since the end of its final privatisation, Telstra was the darling of mum and dad investors, who saw Telstra as a ‘national champion’ that could provide sustainable income over a long period of time. Telstra’s fundamentals came under threat in the form of competition from the NBN and other players like TPG, diminishing fixed-line revenue, and a crippling bureaucracy.

Telstra’s new strategy, named Telstra2022, splits out the telco’s infrastructure into a separate business and aims at reducing costs and improving customer service.

Whether investors consider re-entering Telstra should depend on whether this strategy can improve the telco’s long-term prospects, rather than the success of short-term measures to boost profit and distributions.

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