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Telstra - a matter of interest

Many high profile Australian stocks are under pressure, despite the fact the share market is within a few percent of ten year highs. Major banks, Telstra, AGL and others are at or near multi-year lows. In many cases there are sector or stock specific reasons, but these may obscure a “big wave’ that is affecting markets globally, and investors cannot afford to ignore.

Telstra’s growth concerns are now well exposed. Beyond the roll-out of the NBN there is a large earnings hole. At this stage there is no easy way forward for management. Telstra is the largest Telco in Australia and its margins are wider. This means organic growth is not the answer. The longer term choices for Telstra are shrink, break up or make a significant acquisition.

The underlying problem for Telstra shareholders compounds this issue. Longer term interest rates are rising. The US ten year bond breached the 3% level, and many other countries’ bond curves are showing higher yields. While weaker growth in Japan and Europe may slow the climb of interest rates the long cycle appears to have turned.

Higher interest rates diminish the importance of dividend yields. Why would income seeking investors take the capital risks of share ownership if they can source income from more capital stable bonds?

This is a double hit to Telstra’s investment profile. The appeal of dividends yields is dropping, and so is Telstra’s dividend. The situation looks like a classic dividend trap. Shareholders tempted to “double down”, and buy more Telstra at the now much reduced share price, may suffer further.

This principal applies to other stocks and sectors. There’s little doubt the Royal Commission inquiry is weighing on the financial sector.  However this is potentially obscuring the impact of higher interest rates on the investment case for banks that are largely held for dividend yields. Utilities like AGL, with the focus on the future of the Liddell power station, are comparable. Shorter term factors are grabbing the headlines, and hiding the impact of the global shift.

The changing macro environment demands a shift in investment strategy. Income streams could become less important, and growth exposures more vital. The good news is that the interest rate sensitive property sector has rallied around 9% over the last three months. Investors looking to shift their portfolios could start there.

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