Telstra’s Road to Dividend Growth

By David Dittman • October 18, 2012 • Pacific Digest

Catherine Livingstone, chairman of AE Portfolio Conservative Holding Telstra Corp Ltd (ASX: TLS, OTC: TTRAF, ADR: TLSYY), said this week at the company’s annual general meeting that it hopes to return to dividend growth in 2014 and to stick to regular increases every six months beginning in that fiscal year.

The dividend for fiscal 2013 will remain a fully franked AUD0.28 per share “subject to the normal approval process, and there being no unexpected material events.” Telstra is sticking with two-year dividend guidance initially issued during its October 2011 annual general meeting.

This timeline was established with Telstra’s “capital management framework” in mind as it made its way through final negotiations over its participation in and contribution to Australia’s National Broadband Network (NBN).

Long-term capital management goals remain in place: to maximize returns to shareholders; to maintain financial strength; and to retain financial flexibility. The short-term concern of NBN negotiations no longer operative and its “over-arching” framework now well established, Telstra in fiscal 2014 will return to its normal practice of “considering dividend on a half yearly basis.”

Telstra has been a significant winner since it debuted with the other seven of our “Eight Income Wonders from Down Under” as the components of our initial Portfolio in the inaugural issue of Australian Edge on Sept. 26, 2011. Through the close of trading in Sydney on Oct. 17, 2012, the stock had generated a total return in US dollar terms of 52.67 percent.

The S&P/Australian Securities Exchange 200 Index is up 31.27 percent during this timeframe and on US dollar terms. The S&P 500 Index, meanwhile, has returned 28.64 percent, the MSCI World Index 24.48 percent.

From the end of the first quarter of 2012, when concerns about Europe and slowing global growth reemerged, the stock is up 22.19 percent in price-only terms. The S&P/ASX 200 is up 4.45 percent in local, price-only terms, the S&P 500 3.72 percent, the MSCI 2.11 percent.

Much of Telstra’s outperformance is based on the reliability of its operations performance and the ample cash flows they generate in a tense time for investors. Telstra is able to consistently reinvest in its all-important wireless network and to sustain one of the most generous payouts in the global telecom space.

Investors did sell the stock hard in mid-August, when the company announced fiscal 2012 results and reiterated its plan to emphasize network reinvestment and financial strength and flexibility over a share buyback, a raised dividend or a special payout. The stock slid from a three and half year closing high of AUD4.07 on Aug. 6 to AUD3.70 two weeks later.

Telstra is trading around AUD4 as of this writing, with a dividend yield of 7 percent. The share-price rally this year has been driven by the flight to its quality as well as the finalization of its NBN arrangements and continuing recognition of its ability to invest in its network.

But Telstra hasn’t raised its dividend since February 2005, and it hasn’t declared a special dividend since November 2005. We boosted our buy target in mid-2012 on the NBN deal. But we’ve held firm since, as our primary criteria for higher valuation is dividend growth over time.

That’s not to say Telstra isn’t building a more valuable business. Quite the contrary, in fact, as last month the company announced a plan to spend AUD1.2 billion to expand its 4G network so it covers 66 percent of the Australian population by mid-2013, up from 40 percent coverage at the time of the announcement.

This level of investment separates Telstra from would-be competitors in its home market. Mobile network traffic is doubling every year, as smartphone connections to wireless broadband networks proliferate. Connectivity is driving telecom growth, and Telstra is better positioned than its competitors to capitalize because of the way it’s managed its cash flows.

Demand for data is growing exponentially, as traditional voice and messaging services are joined by new demand for video, social networking and real-time mapping capabilities. Business users want access to enterprise via secure networks that Telstra also provides.

Turning customer demand for mobility into long-term shareholder returns is Telstra’s top priority. But network applications, web browsing and “the cloud” are the drivers of growth in this new era, as opposed to phone calls.

Telstra rolled out its 3G network in 2006; it covers 99 percent of Australia’s population. The upgrade to 4G will expand the capabilities of what’s already the largest mobile broadband network Down Under, with faster speeds in more places. Telstra reported 8.5 percent growth in mobile revenue in fiscal 2012 to AUD8.7 billion.

Telstra’s fixed-line network is also adjusting to this new telecom world, as demand for video has pushed annual traffic growth to 50 percent. During the 2012 Australian Football League season Telstra provided 1.7 million mobile video streams but nearly 15 million fixed-network streams.

The company has sold more than 400,000 of its proprietary T-Boxes, a personal video recorder/high-definition TV tuner with Internet access that’s enabled the download for viewing of more than 5 million movies through the BigPond on demand service.

A third key trend in telecommunications is the use of network applications and services, which is widely referred to as “cloud computing.” Cloud-based services and storage are growing in parallel with data usage. Telstra’s goal is to deliver data to any device, anywhere on its network, anytime its customers want it.

Telstra conceives of its network as its platform for innovation. The “smarter” its network, the more likely the apps it hosts will help end-users satisfy their entertainment or business needs. During fiscal 2012 revenue for Telstra’s Network Applications and Services unit grew by 10.5 percent to AUD1.3 billion.

The cloud was Telstra’s fastest-growing revenue segment in fiscal 2012. The company continues to leverage existing relationships with large Australia-based enterprises and government entities, and part of its Asian expansion is based on “following” Australian businesses as their operations expand into greater Asia.

Telstra has completed a couple relatively small acquisitions in recent months that will allow it to develop applications and solutions in-house for its growing roster of network services clients.

Telstra’s ability to invest in its infrastructure on a scale domestic competitors simply can’t match will help it win business of large enterprises that want a solution that includes hosted networks and applications. And more and more companies–as they attempt to cut costs–will follow this route.

As Australia continues to roll out the NBN Telstra’s considerable suite of media content will also continue to generate solid growth. In this segment Telstra doesn’t care how the customer accesses the network because the customer will be accessing Telstra content. At the same time, its 4G network will make the user experience much better for customers demanding more and more services, accessing networks in more and more ways.

4G is all about speed and reliability, and Telstra is the king in Australia.

One area management continues to focus on is customer service. Part of their efforts–the major part, in fact–is on providing the fastest, most reliable network in Australia. Another part is streamlining the actual customer contact experience so users stick with Telstra and actually become advocates on its behalf.

This is a big leap. But customer attraction and retention is probably the most important factor for a 21st century telecom. Telstra has added 3.3 million customers over the past two fiscal years, in a population of 28 million “sim cards.” (Australia’s actual population is 22 million, but some people have more than one mobile device connected to a network.)

This is impressive growth. Better performance at the customer service level, in management’s view, will also drive better performance at the financial level…and that will translate, eventually, into dividend growth.

Management sees great potential for “cloud” growth in Australia as well as across Asia. Company-wide management expects “growth to continue” in fiscal 2013, with low single-digit income and earnings before interest, taxation and depreciation growth. Management forecast cash flow for the fiscal year of AUD4.75 billion to AUD5.25 billion.

The Roundup

The three major resource-focused companies in the AE Portfolio Aggressive Holdings released quarterly production reports this week.

Highlights from BHP Billiton Ltd’s (ASX: BHP, NYSE: BHP) update include record petroleum production of 666,000 barrels of oil equivalent per day during the three months ended Sept. 30, 2012.

BHP’s Atlantis and Mad Dog facilities in the Gulf of Mexico successfully recommenced production, driving a 17 percent quarter-over-quarter increase in liquids (crude oil, condensate and natural gas liquids) output.

Petroleum production guidance for fiscal 2013 remains unchanged at 240 million barrels of oil equivalent, including an expected 15 percent increase in liquids production, largely attributable to BHP’s onshore US business and its Gulf of Mexico facilities.

Western Australia Iron Ore put up solid numbers despite the impact of a planned shutdown associated with the Inner Harbor Expansion project. Production was up 1 percent year over year but down 3 percent quarter over quarter. Iron ore, BHP’s biggest product by sales, averaged USD112 a metric ton at China’s Tianjin port in the quarter, down 36 percent from a year ago, according to The Steel Index Ltd.

Pilbara operations achieved another significant milestone during the quarter, with first ore loaded from two recently installed shiploaders at Nelson Point. Iron ore production guidance remains unchanged, with a 5 percent increase forecast for fiscal 2013.

Metallurgical coal volumes from its Queensland Coal operation were up 20 percent, as BHP Mitsubishi Alliance production increased to over 80 percent of supply chain capacity. Energy coal production was higher than all comparable periods and reflected strong operating performance across the portfolio. New South Wales Energy Coal (Australia) achieved record quarterly production following the completion of the RX1 project ahead of schedule.

Western Australia Iron Ore achieved another significant milestone with first ore loaded from the two recently installed shiploaders at Nelson Point as part of the Inner Harbour Expansion project.

And copper production from the Escondida project in Chile remains on track to increase by 20 percent in fiscal 2013 following the completion of scheduled maintenance and tie-in activities.

A 24 percent year-over-year increase in production reflected the mining of higher-grade ore at Escondida and the impact of a labor strike in the prior corresponding period. Record quarterly production was achieved at Antamina in Peru, as milling rates continued to exceed recently expanded ore processing capacity.

A reduction in smelter throughput affected Olympic Dam (Australia) production from Olympic Dam in Australia. A 27-day smelter outage is scheduled for the second quarter of fiscal 2013.

Lower head grades at Cannington in Australia contributed to lower lead and silver production, zinc production at Antamina declined as mining progressed through a copper-rich ore zone, and uranium production was broadly in line with all comparable periods.

The ramp-up of the Worsley Efficiency & Growth project in Australia and continued strong operating performance at the Alumar refinery in Brazil contributed to record alumina production in first quarter of fiscal 2013.

Aluminium production was higher than the fourth quarter of fiscal 2012, as potline capacity at Hillside in South Africa recovered following a major unplanned outage in the third quarter of fiscal 2012 quarter. Operations are expected to progressively return to full technical capacity by the end of calendar 2012.

Diamond output was lower than all comparable periods, reflecting temporarily restricted mining conditions and unscheduled maintenance at EKATI in Canada. Although production is expected to recover during the second quarter of fiscal 2013, it is forecast to remain constrained in the medium term as the operation extracts lower-grade material, consistent with the mine plan.

The sale of BHP Billiton’s 37 percent non-operated interest in Richards Bay Minerals in South Africa to Rio Tinto Ltd (ASX: RIO, NYSE: RIO) was completed during the quarter, as management’s review of its diamonds business continues.

An increase in nickel metal reflected strong operating performance at both Cerro Matoso in Colombia and the Nickel West Kwinana refinery in Australia. Total saleable production declined, as nickel matte was stockpiled in advance of planned maintenance at the Nickel West Kalgoorlie smelter.

Consistently strong operating performance and improved plant availability at GEMCO in Australia contributed to record manganese ore production, while the resumption of production at TEMCO in Australia in July 2012 led to a substantial increase in manganese alloy production.

BHP Billiton is a strong buy under USD40 on the ASX. BHP also trades as an American Depositary Receipt (ADR) on the New York Stock Exchange. The ADR is worth two ASX-listed shares and confers all the same rights and benefits, including currency movements. BHP’s ADR is a buy under USD80 on the NYSE.

Newcrest Mining Ltd’s (ASX: NCM, OTC: NCMGF, ADR: NCMGY) production for the first quarter of fiscal 2013 was 460,425 ounces of gold, down from 587,310 ounces for the fourth quarter of 2012 but in line with guidance, and 18,598 metric tons of copper, down from 20,544 metric tons but also in line with guidance.

Cash costs were AUD703 per ounce, up from AUD604, and cash margins were AUD880 per ounce, down from AUD970.

Newcrest had forecast output of 460,000 ounces after disruptions at operations in Papua New Guinea and Australia. Newcrest reiterated its annual production forecast from August, saying production will increase as much as 9 percent to a range of 2.3 million to 2.5 million ounces.

Management expects gold production to “progressively increase” over the remainder of fiscal 2013, as the company’s expansion projects at Cadia Valley and Lihir are nearing completion. The Lihir “million ounce plant upgrade” is on track for completion by the end of the December 2012 quarter, while Cadia East should deliver first commercial production in that timeframe as well.

Newcrest updated its ore reserve and mineral resource estimates for its Wafi and Golpu projects following completion of the technical pre-feasibility study for the Golpu deposit. The Golpu deposit is estimated to have ore reserves containing 12.4 million ounces of gold and 5.4 million metric tons of copper. The deposits at Wafi-Golpu are estimated to have mineral resources containing 28.5 million ounces of gold and 9.06 million metric tons of copper.

Newcrest renewed its bilateral bank lending facilities during the quarter, which comprise agreements with 10 banks for USD250 million each, for a total amount of USD2.5 billion, over terms of three and five years. The company also raised USD1 billion during the quarter through the issue of corporate bonds in the US with maturities of 10 and 30 years. Proceeds were used to repay existing short-term debt.

Newcrest Mining is a buy under USD32 on the ASX and on the US over-the-counter (OTC) market using the symbol NCMGF.

Newcrest also trades as an ADR on the US OTC market, under the symbol NCMGY. Newcrest’s ADR, which represents one ASX-listed share, is a buy under USD32.

Rio Tinto Ltd (ASX: RIO, NYSE: RIO) reported record quarterly Pilbara iron ore production of 63 million metric tons, of which its share is 50 million metric tons, 5 percent higher than the third quarter of 2011.

Global iron ore production for the quarter was 67 million metric ton, with Rio Tinto’s share 53 million metric ton), also 5 percent higher than the third quarter of 2011. Rio Tinto expects to produce approximately 250 million metric tons from its global operations in Australia and Canada, subject to weather constraints.

Total mined copper production was 21 percent higher than the third quarter of 2011, due to expected higher copper grades at Escondida and Kennecott Utah Copper and increased ore delivered at Escondida.

As of the time of its quarterly report construction of the Oyu Tolgoi copper/gold project was currently 97 percent complete. On Oct. 15 Turquoise Hill Resources announced that Rio Tinto, Turquoise Hill and Oyu Tolgoi LLC had jointly rejected a request from the Government of Mongolia to renegotiate the Oyu Tolgoi Investment Agreement.

This followed receipt of a letter from the Mongolian minister of mining requesting the parties renegotiate the agreement that was signed in October 2009 and became fully effective in March 2010. As recently as October 2011, the Mongolian government reaffirmed that the Investment Agreement was signed in full compliance with all laws and regulations of Mongolia.

Rio Tinto’s share of mined and refined copper production is expected to be approximately 560,000 metric tons and 290,000 metric tons, respectively, for 2012.

Bauxite and alumina production were 13 percent and 20 percent higher than the third quarter of 2011, driven by increased third-party demand for bauxite, expanded refining capacity at Yarwun and record production at Gove. Aluminium production was 10 percent lower than the corresponding quarter in 2011, as ramp-up to normal capacity continued following resolution of a labor dispute. Rio Tinto Alcan’s share of bauxite, alumina and aluminium production is expected to be 30.7 million metric ton, 7.0 million metric tons and 2.2 million metric tons, respectively, for 2012. These numbers exclude 13 assets that have been identified for divestment or closure.

Thermal coal production increased 21 percent. Hard coking coal production was 13 percent below the third quarter of 2011, due to the impact of dragline mechanical issues at Hail Creek and a major plant shutdown at Kestrel as part of the mine extension project. For 2012 management expects Rio Tinto’s share of Australian hard coking, semisoft coking and thermal coal production to be 8.5 million metric tons, 3.5 million metric tons and 19.5 million metric tons, respectively.

Titanium dioxide feedstock production increased 5 percent from the corresponding period in 2011.

Uranium production at Energy Resources of Australia was 29 percent higher for the third quarter and production for the nine months to September was 69 percent higher than the corresponding period last year. This followed the completion of dewatering operations in June 2012, which facilitated access to higher-grade ore. Rio Tinto’s 2012 share of uranium production is expected to be 9.7 million pounds.

Rio Tinto is a buy under USD75 on the ASX.

Following are links to our discussion and analysis of the most recently announced financial and operating results for Portfolio Holdings.

Conservative Holdings

Aggressive Holdings

Stock Talk

Comments Guidelines

Add New Comments

You must be logged in to post to Stock Talk OR create an account