TTRAF - Telstra: A 4% Tax-Free Dividend From Australia's Largest Telecom Company

2023-05-11 10:27:00 ET

Summary

• Telstra is the largest telecommunications company in Australia. That has its advantages and the company's revenue and EBITDA are increasing again this year.
• The dividend is fully funded by the free cash flow result but the net income per share is lagging.
• The dividend should be tax-free for foreign investors as it is "fully franked."

Introduction

Telstra ( OTCPK:TLGPY ) ( OTCPK:TTRAF ) is Australia’s largest telecommunications company and a loyal dividend payer. While the current dividend yield is approximately 4%, the additional benefit for foreign investors is the status of the dividend. As Telstra pays corporate income taxes in Australia, its dividend is not subject to a withholding tax.

As Telstra is an Australian company, its ASX listing is for sure the most liquid listing to trade in the company’s shares. The ticker symbol in Australia is TLS , the average daily volume is 23 million shares. As there are 11.55 shares outstanding, the current share price of A$4.30 indicates the market capitalization of Telstra is approximately A$50B. As the company trades in Australian Dollar and reports on its financial results in Australian Dollar, I will use the AUD as base currency throughout this article.

Robust cash flows, but the stock isn’t cheap

I like how Telstra provides a breakdown of its divisions as it doesn’t just break down the revenue but also the EBITDA margins. I also appreciate seeing the company’s infrastructure division continuing to put in a strong performance. The InfraCo division operates as a standalone division within Telstra. As you may have guessed by now, this business unit contains the mobile tower assets, the fiber network and data centers. As you can see in the image below, the infrastructure division has reported a total revenue of A$1.23B in the first half of the financial year, an increase of almost 4%. The EBITDA margin of that division did decrease slightly but with 65.8% , the infrastructure division generates about A$800M in EBITDA. Applying a multiple of 12-14 times EBITDA, this division alone is worth about A$9.6-11.2B.

The total revenue in the first half of the current financial year was A$11.6B and this includes about A$277M in "other revenue" which is mainly related to, for instance, third-party fees and revenues.

The total amount of expenses obviously is relatively high and increased as well compared to the first half of FY 2022, but the EBITDA still increased, from A$3.47B to A$3.86B. And as the depreciation and amortization expenses barely increased, the EBIT actually increased by about 25% to A$1.6B.

That’s a nice jump, and despite the higher net finance costs (up 6% to 252M AUD), the pre-tax income increased by approximately 30% to A$1.35B. The net income was A$934M of which A$865M was attributable to the shareholders of Telstra. This worked out to A$0.075/share based on the current share count of 11.55 billion shares outstanding.

I was hoping to see the company’s free cash flow result coming in higher than the reported net income as the company’s full year dividends have consistently been higher than its net earnings. In FY 2021 and 2022 for instance, the EPS came in at A$0.156 and A$0.144, respectively, while the company declared dividends of A$0.16 and A$0.165 per share.

The cash flow statements in Australia are slightly different from the European or North American rules as the "cash generated from operations" is simply the total cash inflow minus the total cash outflow. So the Australian cash flow statements almost never use the net income as a starting point and that makes it a little bit less transparent.

In any case, the net cash provided by operating activities was A$2.87B and this includes about A$467M in taxes paid which is about A$52M higher than the A$415M the company owed to the tax man based on the income statement.

The total capex (excluding M&A) was A$1.86B but we also should deduct the A$322M in lease payments and the A$68M in cash paid to the non-controlling entities (which is pretty equal to the portion of the net income attributable to those non-controlling interests). Additionally, we should deduct the A$275M in finance costs and add the A$116M in finance income (government grants, interest income and the income from finance leases). This results in an adjusted free cash flow result of A$507M (and this includes changes in the working capital position which could have been a cash drain during the first half of the financial year).

Just to give you an idea of how important those fluctuations can be: In FY 2022, the total net cash provided by operating activities was A$7.25B but only 44% of that amount was generated in the first half of the year. And in H1 FY 2023, the reported operating cash flow was about 12% lower than the H1 FY 2022 result despite a double-digit EBITDA increase.

Investment thesis

This means it wouldn’t be fair to judge Telstra based on its reported free cash flow result in the first semester of the current financial year. Looking at the FY 2022 results and excluding the contribution from working capital changes, the net free cash flow attributable to the common shareholders of Telstra was A$2.28B. Divided over the current share count of 11.55 billion shares outstanding, the net free cash flow result per share came in just below A$0.20 which means that although the dividend of A$0.165/share paid based on the FY 2022 result was not covered by the net income, but it was covered by the adjusted free cash flow result.

The 4% dividend yield is somewhat attractive, mainly because the dividend is "fully franked." This means Telstra has paid sufficient corporate income taxes for the dividend to be tax free. Foreigners pay no tax on a fully franked dividend which is obviously more attractive than the normal tax rate of 30% on Australian dividends.

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