Uncertainty pushes Telstra shares to rock-bottom

Shares in Australia's dominant phone provider, Telstra Corp, have hit a record low, damaged by a triumvirate of falling earnings, uncertain network negotiations and a potential government-enforced split.

Telstra's beleaguered investors have been left wondering whether the worst has passed or whether fresh lows are in the offing, as Australia's senate prepares to debate on March 15 legislation to forcibly split the company's wholesale and retail business if it does not separate itself voluntarily.

Telstra shares have climbed above their lows in recent days on reports the government will not be able to muster the necessary support to pass the bills aimed at increasing competition in the telecom sector. On Friday, Telstra was little changed at A$3.08 (NZ$4.02) after falling to a record low of A$2.88 on March 2 – the lowest since the company was floated in 1997. The stock has lost 11 per cent so far this year.

A major positive for Telstra would be a successful deal to sell its network of copper phone lines to the government-owned National Broadband Network Company, which wants to make a high-speed wholesale internet network readily available to all. The network has seen estimates of value ranging between A$8 billion and A$33 billion ($7.3-$30.3 billion).

"I don't think there's too many people that wouldn't see valuation upside from a resolution of the regulatory and NBN issues, but people are just debating when they're going to come through," said Michael Maughan, senior analyst at fund manager Tyndall Investment Management.

"The market at the moment is pricing in the absolute worst case scenario in terms of what the government could potentially enforce on Telstra," said John Murray, managing director of Perennial Value Management.

Telstra's dividend yield of 9.4 per cent is more than twice that of its main rival in the Australian market, SingTel's Optus, but just short of Telecom New Zealand's return. Telstra has maintained its forecast of A$6 billion of free cash flow for the year to June 30, 2010.

"Despite an apparent loss of revenue momentum, our modelling continues to highlight a 28 cent dividend is sustainable even under bear-case NBN outcomes," UBS analyst Richard Eary said in a note. Eary rates the stock as a buy with a 12-month target price of A$4.00.

"Even if they had to cut the dividend by, say, 25 per cent, you're still getting what we'd consider a very good running yield," Murray said.

Telstra's half-year results in early February showed an accelerating decline in earnings from its traditional fixed-line calling business.

"The guidance they've given after the results was a lot weaker than what most people had in their models," said Theo Maas, an analyst at Fortis Investment Partners. "It's clear they're losing market share."

That has seen brokers reduce the company's 12-month price target. According to Starmine data, since Telstra's half year result 13 brokers have cut estimates for Telstra's earnings per share for the year ending June 2010.

"We think Telstra is a business in decline," said Chris Cahill, portfolio manager at Quest Asset Partners. "We actually don't think the yield is safe."

Other factors could also weigh. The Australian government still has 10.9 per cent of Telstra, held in its Future Fund, which has said it would prefer a lower stake as part of a more balanced investment portfolio.

Telecom New Zealand shares have more than halved since legislation to enforce a split of its retail and wholesale businesses was unveiled in 2005.

The problem of Telstra's declining earnings is obvious but the solution is not, said Fortis' Maas.

"For most incumbent telecoms operators it's clear that the most high-margin business, that fixed line business, is moving away to mobile and to voice over the internet," Maas said.

"It's hard to stop it and there's not much they can do in my view to halt those trends," he added.

- Reuters