Sydney View: Telstra drifts aimlessly in market limbo

By GILES PARKINSON*

Telstra is suffering an identity crisis. It is Australia's biggest stock by market capitalisation, profits and political controversy, and yet it is also one of the hardest stocks in the country to value.

That may have something to do with the fact that many of its investors paid A$7.40 a share when the second tranche of shares was issued in 1999.

The stock is now trading at less than A$5 and it is difficult to get used to the idea that it may not be worth A$7.40 for a very long time.

But the valuation dilemma is also because the telecommunications giant has a relatively lousy growth outlook and doesn't pay a big dividend. That means Telstra is neither a yield play nor a growth stock, or neither fish nor fowl to analysts who want to put a stock in one box or another.

And for as long as the Australian Government hangs on to its 50.1 per cent stake that will continue to be the case.

"Telstra's stock is hard to categorise for investors," said one prominent analyst in a report last week. "It is neither an attractive yield story (like property trusts) or a high earnings growth play (like Westfield Holdings or Woolworths)."

Analysts may well be more polite about Telstra than they need to be because the investment banks that employ them hope to get a role in the third Telstra sale - a likely A$30 billion ($35 billion) issue - but none are suggesting to their clients that the stock is worth more than A$5.20 in the present climate.

Indeed, they are not likely to get excited about the stock until it can either prove that its earnings are about to grow or that it will lift its dividend. And therein lies a problem that cannot be quickly resolved.

Telstra last year spat out more than A$3.8 billion in what analysts call free cash flow. More than A$2.8 billion of this was paid to shareholders in the form of a dividend, but the extra A$1 billion was used to pay down debt.

"Telstra is spinning out more cash than it knows what to do with," lamented one broker last week.

Another noted that if that money had been distributed as a dividend, the stock would have been paying a yield of around 5.8 per cent rather than 4.6 per cent, making a big change in valuation models.

The fact that it didn't suggested that Telstra is either awaiting parliamentary approval for a full privatisation, which it would celebrate with a special dividend or share buyback, or it is considering an acquisition in Asia.

The latter makes analysts nervous, because Telstra can only use cash and debt to make purchases, as any issue of shares will dilute the Government shareholding to less than a majority.

The revenue outlook is not so rosy either.

The number and price of local phone calls is declining, the data and internet division is showing no growth and mobile phones, despite a 10 per cent rise in the past year, are not expected to grow as strongly in the coming 12 months.

It may well be why Telstra executives were not commenting. Chief executive Ziggy Switkowski insisted that the number of market imponderables meant that it would be "reckless" to make any sort of forecast for the company. Certainly, it could have unintended effects on the share price.

For the moment, though, it still enjoys relatively high valuations compared with its global peers.

Like the Australian stock market in general, Telstra's declines in the past year have been small compared with those in the US and Europe.

That may be a double-edged sword. Analysts suggest that when the telco industry does show signs of global growth, the temptation for international investors will be to invest in the offshore stocks that show greater leverage for growth.

Which means that until the Australian Government can push through its privatisation, the Telstra share price, its capital management and its growth plans will be stuck on hold.

* Giles Parkinson is deputy editor, new media, of the Australian Financial Review.