Telcos no place to find sustainable dividends in future

Australia’s telecoms stocks have recently suffered a stretch that I could only describe as horrible, amid a very challenging industry pricing backdrop. The S&P/ASX200 Telecommunications Services Index has tumbled 33 per cent in the past 12 months alone.

Many concerns have driven telecoms stocks lower, but the hazy outlook for dividend payments is what is making me steer clear of this sector for retirees seeking a regular franked income stream.

Until last year, Australian telcos paid a reliable – and often rising – stream of dividends to investors. But that stream is beginning to dry up as telecoms slash prices to compete for customers, and also face the upcoming cash call for 5G spectrum and the associated new infrastructure.

A question mark now hangs over the industry’s future ability to pay investors a sustainable dividend.

Telstra, TPG, Vocus Communications – the owner of Commander, Dodo and iPrimus, have all either cut or announced plans to cut their dividends.

And just this week Telstra announced dramatic job cuts of one-in-four people over four years as it seeks to cut costs and streamline products.

If investors haven’t started to wonder whether they can rely on the sector as a source of income, then they should start to now.

The telco oligopoly is becoming more competitive, and the profit pool of the industry is shrinking as new rivals are emerging amid a price war.

One of the biggest challenges facing the telecoms companies is the impact on profit margins and cash flows of ferocious competition. This includes TPG’s decision to enter the mobile phone market and provide 6 months of mobile data plans for free, putting pressure on other telecoms operators to follow suit.  All of this is a further cashflow challenge for an industry which is about to undergo a large capital expenditure cycle for the next generation of technology (5G).

Thankfully it’s not all doom and gloom for telcos. They can cut costs and make productivity gains. As mentioned above, Telstra has just announced plans to cut costs and streamline products.

There is an argument that we have seen the worst of dividend cuts from Australia’s telcos. That may well be right. Some analysts are forecasting for telco dividends to stabilise in the short/medium term and even rise slightly in the next few years.

But there is a risk that competitive tension in the industry gets even worst and pressures the weaker players in the industry. Some Australian telco players have previously paid almost all profits out in dividends, but I think reduction to between 70 per cent and 90 per cent of profits is likely and will align this country with global peers.

Overall, I think the uncertainty overhanging the telecommunication industry, from competition and uncertain payoffs from big investment, means there are still significant risks to dividend payments.

Retail investors, in particular, should be mindful that if they want confidence that they are investing in companies with sustainable dividends, then they should probably look elsewhere. What this means for investors is that they need to think about whether their personal goals at this point in time align them more toward a sustainable dividend payer or shares that have different growth characteristics.