Shares in Telstra (ASX: TLS) have taken a big hit due to heated competition in the telecommunications market and the rollout of the National Broadband Network (NBN). But now could a good time to invest in the stock, according to some analysts.

Telstra shares fell to a five-and-a-half-year low of $3.37 in October on pessimism about its earnings outlook and after the company announced it would cut its dividend payout in August. Telstra shares are currently trading around $3.43, giving a dividend yield of around 6.4 per cent, fully franked.

Fears about the NBN taking away its earnings have also weighed on Telstra. Once fully rolled out between 2020 and 2022, the NBN is expected to siphon up to $3 billion a year from Telstra's earnings, says Morningstar telecommunications analyst Brian Han.

But he thinks the stock has been oversold and fears about the company's prospects overstated.

"We think Telstra is now undervalued. We think there is too much pessimism priced into the stock at the moment and have a fair value on the stock of $4.60, and the stock is trading at a significant discount to that level," says Han.

"The market is concerned about competition and that even the revised dividend isn't sustainable.

"Competition is getting more and more intense--even more intense than we had anticipated. But we do believe the dividend is sustainable. We think the company has a reasonable buffer to maintain that level of payout and Telstra has a very solid balance sheet to support it."

Telstra in August announced it would cut its 2017-18 full-year dividend payout by 30 per cent to just 22 cents per share. That reverses the company's former policy of paying out almost 100 per cent of the company's underlying earnings to a range of 70 to 90 per cent.

"While competition is bad for Telstra, the company is well placed to deal with it compared to TPG (ASX: TPM), Optus, and Vocus (ASX: VOC). The company's balance sheet is stronger compared to its peers and Telstra is coming from a position of strength because it is the market leader across all segments of the market," says Han.

"They hold about 50 per cent of the broadband market, just under 50 per cent of the mobile market, and in corporate telecommunications, they hold about 50 per cent of the market too."

Telstra recently responded to broadband competition by launching unlimited data for all customers on $99 and above plans. Customers on plans under $99 will also receive a major data boost, at least doubling their existing plan allowances automatically.

Stockbrokers also expect Telstra's price to move higher. The consensus forecast of eight stockbrokers surveyed by FNArena is that Telstra shares are worth $3.79.

Some institutional investors are eyeing the stock. Alphinity, an Australian value investment manager, said in an October update that Telstra looks cheap. The investment manager has been underweight Telstra since August 2015 due to mobile competition and NBN pressures, but is now considering turning that position around.

"Telstra currently appears quite cheap on some valuation metrics … although it has a declining earnings outlook and its annual dividend has been cut from 31 cents to 22 cents, removing some of the yield support," says Alphinity.

"However, the Alphinity process ensures that we will patiently wait until our research shows it has the potential to return to an earnings upgrade cycle. At that point, providing its valuation is attractive, we will consider moving to an overweight position again."

But not everybody is convinced. Perennial Value Management recently reduced its exposure to Telstra due to increasing competitive pressures.

As for Vocus, the company still has internal problems to resolve before investors can be confident of a full turnaround, says Han. Vocus shares fell to a four-year low of $2.26 in September after the company in May unveiled its second profit downgrade in seven months.

Concerns about the state of the company's accounts has also weighed on investors after two private equity firms walked away from Vocus after weeks of due diligence.

"Vocus had been sold off and so it has recovered from those lows. I think it's too early to say that everything is fine and dandy. It is a company in transition. There is still a lot of work that needs to be done internally," says Han, who has a fair value of $3.00 on the stock, though noting that investors' confidence has increased as the company makes progress on its transformation plan.

More from Morningstar

• Who doesn't love a little action?

• Should you buy currency ETFs?

• Make better investment decisions with Morningstar Premium | Free 4-week trial

 

Nicki Bourlioufas is a Morningstar contributor and owns shares in Telstra. This is a financial news article to be used for non-commercial purposes and is not intended to provide financial advice of any kind. Opinions expressed herein are subject to change without notice and may differ or be contrary to the opinions or recommendations of Morningstar as a result of using different assumptions and criteria.

© 2017 Morningstar, Inc. All rights reserved. Neither Morningstar, its affiliates, nor the content providers guarantee the data or content contained herein to be accurate, complete or timely nor will they have any liability for its use or distribution. This information is to be used for personal, non-commercial purposes only. No reproduction is permitted without the prior written consent of Morningstar. Any general advice or 'class service' have been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), or its Authorised Representatives, and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. Please refer to our Financial Services Guide (FSG) for more information at www.morningstar.com.au/s/fsg.pdf. Our publications, ratings and products should be viewed as an additional investment resource, not as your sole source of information. Past performance does not necessarily indicate a financial product's future performance. To obtain advice tailored to your situation, contact a licensed financial adviser. Some material is copyright and published under licence from ASX Operations Pty Ltd ACN 004 523 782 ("ASXO"). The article is current as at date of publication.