Opinion: Christmas comes early for yield-hungry Telecom investors

By Simon Louisson of NZPA

Friday 6th August 2004

Christmas came early for Telecom investors with the company declaring a 27% increase in its dividend yesterday.

The telco reported a 6.3% rise in its June year net profit to $754 million at the top end of expectations.

Telecom's shares had run up 12% since early June in anticipation of stronger payouts and all year analysts have been talking about that prospect, with the stock rising 36% this year.

But in the event, the company managed to outdo expectations.

The quarterly dividend was increased to 9.5 cents from 7.5 cents and the company said it would hold it at that level for the next three quarters and then make a final payout that will bring it to 85% of profit.

Given that chairman Roderick Deane said Telecom was comfortable with the consensus profit forecast of $821m for 2004/5, that suggests a dividend payout of $755m - slightly more than 9.5c per quarter.

Speaking at the result media briefing, Deane said the dividend increase and change of policy to pay out at least 75% of profits "represents the board's confidence in the future outlook for Telecom".

But you could read it another way - that Telecom has no real investment growth prospects and therefore has little choice but to return profits to investors.

"The flip side of that (higher dividends) is, how much growth there will be in the long term, and I think that's where the question marks are going to be asked of Telecom," Brook Asset Management fund manager Simon Botherway told National Radio.

Chief executive Theresa Gattung confirmed the back to basics approach.

"Don't expect to see any sudden rush of blood to the head and us wanting to rush offshore and buying things that are completely unrelated to our core business. We are pretty focused on the basics, doing the basics well, and on effective capital management."

It is five years to the week since Gattung was appointed chief executive at the age of 37.

The share price was then $8.65 - some 29% above today's price. That equates to a $4.8 billion loss in value - quite a bit when you consider her salary. The recent surge in the share price will allow her to double her $1m base salary. She was issued half a million "performance options" in November".

However, to put Telecom's five-year share price fall into perspective, it should be noted the overall market has dropped nearly as much - 22% - over the same period.

The company in 1999 was being priced on potential growth and the tech boom was in just getting into full swing.

Gattung's main idea contribution then was to cut the dividend payout ratio of 80-100% of net profit to 50%, and to use the extra cash to fund growth, especially in Australia. Although already deeply into AAPT, she took the company in deeper.

It has proved a dismal investment in terms of returns although it could be argued that not having a considerable presence in Australia was not an option for a company like Telecom. Even after a $850m write-down in 2002, Telecom values AAPT at $1.5 billion.

Botherway said that while Australian operations were no long contracting, he doesn't expect earnings growth there because of the fiercely competitive market.

Share price action following the result was all over the place. Initially the shares rose 10c on the dividend increase announcement, but then the stock was pegged back as the early enthusiasm evaporated and today they fell along with the overall market.

Tower Asset Management investment manager Paul Robertshawe said the guidance in relation to dividends in 2004/5 taken together with target debt levels implied "further upside" for dividend payouts.

Telecom's capitulation on dividends is simply recognition that New Zealand have traditionally demanded high payouts and those that don't tend to be punished.

Some 27% of the company is New Zealand owned and 19% Australian owned. Deane said he expected Australasian ownership to top 50% soon.

As well as the dividend surprise, the result from the underperforming AAPT was better than expected even after a couple of abnormal gains were stripped out.

But on the negative side, New Zealand business costs grew faster than revenue and "the mobile business looks like its still got quite a way to go in terms of being fully competitive against Vodafone", said Robertshawe.

Despite much money and effort put into mobile, with initiatives such as the $10/month texting, Telecom continues to lose market share to Vodafone, which has 55% of the market. And costs have been pushed up.

"They have certainly upped their game, but it hasn't delivered the results yet," said Robertshawe.

Despite heavy investment in mobile, Telecom won only 15,000 new customers during the quarter against Vodafone's 67,000.

Gattung's positive spin was that a year ago Telecom was not getting any of the growth in the mobile market. Now, it was getting some plus getting double digit growth in mobile revenue in the last quarter.

Botherway said it was too early to condemn Telecom's efforts in mobile as only recently did it get handsets comparable to Vodafone's.

"The real bright spot was the underlying broadband data growth, the result really of robust economic growth," he said.

The other strong spot was the balance sheet and the cash flow. Debt is now $3.76 billion, down by one fifth, and that is likely to continue into the current year. The company has $500m in cash and by April will have $700-800m to repay debt.

Telecom has no desire to improve its single A rating.

Forsyth Barr analyst Jeremy Simpson said the strong free cash flow plus Telecom's highly liquid shares gave the stock excellent defensive characteristics.

He said it was not just the higher dividend that has resulted in the share price rally this year.

"It's a combination of a whole host of things - its management delivering against some of its stated objectives in the last couple of years, the market has improved confidence in management, the equity market's been strong, up 30% in the last year, the economy's been strong, there's increasing Australian investment on the register, the regulatory environment has been a bit better than expected a year or two ago."

Both Forsyth Barr and Macquarie Equities are picking Telecom shares to rise to $6.70 within the next year.

Simpson said that given that the dividend yield was the equivalent of a pre-tax 9.3% return, the stock was not over-priced at current levels.

"Even though the share price has had a good run, the share price doesn't look too bad," he said.

Comments from our readers

No comments yet