Optus price rises calm Telstra nerves but concerns continue

Telstra’s dividend yield has started to hit the historic buy zone but it’s hard to see much of a recovery for what has probably been the worst large-cap buy recommendation by analysts this year.

Optus has announced 5 to 6 per cent increases in mobile phone plans, easing concerns of a price war with Telstra.

Telstra’s dividend yield has started to hit the historic buy zone but it’s hard to see much of a recovery for what has probably been the worst large-cap buy recommendations this year.

Indeed Telstra was one of the highest conviction buys by some big brokers at the start of the year, when interest rates were expected to be slashed on the back of rapid disinflation.

But the share price peaked near its 200-day moving average just above $4 in early February. After which the company narrowed its earnings guidance on the back of worsening trends in its network application services business, the share price hit a three-year low of $3.39 last week.

Of course the interest rate outlook has changed and the US rates market now expects little more than one 25 basis point cut by the Fed this year after in January pricing in as many as seven cuts.

While some economists expect the RBA to cut in November, the Australian interest rate market isn’t priced for a rate cut until well into 2025. Earlier this year rate cuts were expected around mid year.

After the job cuts, cost cutting and earnings guidance announced by Telstra its shares traded 23 per cent below what was until recently the consensus 12-month price target of $4.46.

Some analysts had Telstra as one of their top picks of 2024 with price targets as high as $5.10.

Telstra shares are down 10 per cent year to date, versus a 2 per cent rise in the ASX 200.

Analysts have dialled back their bullishness in the past week and the consensus 12-month price target on Bloomberg is now sitting at $4.15. The lowest price target forecast now sits at $3.

Still, the consensus rating is mostly at buy, which is not good from a contrarian basis.

No doubt the 200-day moving average line, now at $3.85, will be a key resistance level in the event that Telstra does find a significant bullish catalyst in the coming months.

It’s not all bad news though as solid increases in mobile phone plans by Optus announced on Monday week helped calm fear of an “irrational market” or price war in mobiles after last week’s scare when Telstra unexpectedly said it would cut its CPI-linked annual price review for its postpaid mobile plans.

Telstra rose as high as $3.57 on Monday, having bounced as much as 5 per cent above last week’s low. It was the biggest share price recovery in Telstra so far this year.

Long-suffering investors weren’t taking any chances though. The share price on Tuesday closed little changed at $3.51.

Solid mobile plan price increases by Telstra would certainly go a long way toward restoring confidence in the share price outlook but aren’t expected in the short term. Meanwhile, it’s hard to see much of a rebound without a significant increase in confidence about disinflation and interest rate cuts.

After all, Telstra is a “yield stock” and its prospective dividend yield – assuming the dividend isn’t about to be cut – has only just hit the start of the historic “buy zone” above 5 per cent.

At $3.50 a share, Telstra offers a dividend yield of about 5.25 per cent or 7.5 per cent including franking credits. Historically investors have demanded at least 5 per cent net to buy Telstra.

However, that depends on the interest rate environment as well as confidence in the dividend.

In the deflationary era after the GFC and mining boom, Telstra’s share price hit a 14-year high of $6.73 and its net dividend yield hit 4.7 per cent. But in early 2018 the share price dived to $2.60 as the dividend was cut, sending the net dividend yield soaring to 7.8 per cent.

Then in early 2022, when the cash rate was near zero and 10-year US Treasuries were yielding about 1.1 per cent after the Covid-19 shock, Telstra’s net dividend yield was bid down to 3.77 per cent

The share price was trading around $4.30 at that time. Later that year as Telstra managed to rebuild its dividend, its share price only managed to hit $4.46 as central banks unleashed the sharpest interest rate rises in decades. Net dividend yields around 4 per cent at that time proved hard to sustain once the cash rate hit 4.35 per cent and the 10-year US Treasury yield hit 5 per cent.

Analysts said the 5 to 6 per cent increases in mobile phone plans announced by Optus were encouraging for Telstra to the extent that they debunked concern about a looming price war.

“We view today’s price hikes by Optus positively, as mobile rationality continues across the industry,” UBS analyst Lucy Huang said.

UBS continued to be positive on Telstra’s ability to put through further price increases in mobiles, despite removing CPI indexation in postpaid mobile contracts, amid a focus on returns on invested capital.

“We note both key competitors have now put through above-CPI price increases – Vodafone up 9 per cent back in late March, and now, Optus up 5-6 per cent,” Ms Huang said.

“We remain watchful on Telstra’s next price change, with our base case assuming 3 per cent postpaid average revenue per user growth in fiscal 2025, driving growth in the dividend from 18 cents in FY24 to 19c in FY25.” That would certainly increase the value proposition.

Goldman Sachs also saw it as a “positive step for industry rationality” after “significant uncertainty” last week when Telstra removed its CPI-linked mechanism.

“From here, although Telstra is technically able to increase mobile pricing on July 2nd, we would expect pricing changes to now be introduced on completion of the current EBA negotiations and enterprise restructure, so are unlikely until late calendar 2024,” GS analyst Kane Hannan said.

But the FY25 earnings guidance range was wider than normal and “could potentially be narrowed at FY24 results in August, to reflect the greater clarity around their mobile pricing outlook”.

Macquarie Equities said that the above-inflation price increase was “positive for the group and industry more broadly”, but considered it as more of an “incremental positive” as it said Optus was “playing catch-up on mobile pricing”.

“We think the equity markets will take a ‘watch-and-see’ approach after today’s pricing change from Optus,” Macquarie’s Darren Leung said.