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Summary

  • Company’s IPTV/FTTx services set to improve future earnings growth.
  • TU offers solid dividend yield of 3.8% and the stock offers potential price appreciation of 11%.
  • Company has a strong balance sheet.

In the recent past, TELUS Corp. (NYSE:TU) has positioned itself among the fastest growing telecom companies in Canada. The company's wireless operations remain strong and are its main growth driver. The company's ability to get an increasing subscriber base in the wireless segment has provided it with chances to outperform in the near future. However, TU's wireline segment is experiencing relatively modest results, due to a highly competitive environment. The company continues to pass on the benefit to investors with an attractive dividend yield and strong share buybacks. TU's cash flows remain slightly depressed due to strong growth investments to improve its infrastructure. However, the company's strong balance sheet, with no significant upcoming debt maturities, shields its cash flow position for the near future. Moreover, the recent spectrum acquisitions will help the company improve its services and grow its bottom line. Based on my price target calculations of $41 for TU, the stock offers a potential price appreciation of approximately 11%.

The Canadian Telecommunication industry is highly competitive and mature, with three key players, namely Rogers (NYSE:RCI), BCE Inc. (NYSE:BCE) and TU dominating the market. TU has been delivering a healthy performance in the recent past, evident by its healthy return on investment (ROI) of 197%, in comparison to RCI's and BCE's ROI of 72% and 150%, respectively.

Wireless - Giving the Head Lead to TU
Despite the intense competition in the wireless segment, TU has been successfully increasing its subscriber base in recent quarters. Subscriber additions for TU were mainly driven by its superior network performance; in 2013, the company achieved 113,000 net wireless subscriber contracts of high-end smartphone customer, higher than its competitors. Moreover, its 4G LTE networks covered approximately 81% of the Canadian population by the end of 2013, up from two-thirds of its population coverage in 2012. The company's LTE services on HSPA+ network cover more than 99% of the population. With strong network services, TU's wireless segment is likely to continue to deliver healthy results in the future. The following chart shows net wireless subscriber contracts from high-end smartphone users in 2013 for TU, RCI and BCE.

Source: Reuters

The following graph represents total net wireless subscriber additions (in '000) for the recent four quarters.

Source: Company's Quarterly Earnings Report

In 2013, a 4.8% year-on-year increase in the segment's revenues due to strong adoption and usage of smartphone and data applications, as well as higher roaming volumes, drove ARPU and margins growth for TU. The company's strong performance in the wireless segment points to its healthy growth trajectory in the near future and I believe it will continue to outperform its peers in the wireless segment. The following graph shows the increasing revenues ($-millions) in all quarters of 2013 for TU.

Source: Company's Quarterly Earnings Report

The following table shows improved EBITDA and blended ARPU of TU's wireless segment in 2013.

2012

2013

EBITDA Margin

41.76%

42.15%

Blended ARPU

$60.39

$61.38

Source: Company's Annual Earnings Report

Wireline Operations Stays Relatively Weak
Wireless substitution and increasing promotional activities in the sector are headwinds for TU's wireline segment. The changing telecom industry trend shifted customer attention from wireline to wireless and cable segments. TU's peers have tried supporting their wireline segment's results by going for intense promotional activities. Meanwhile, TU didn't participate in the heating promotional activity session of the sector to address the change; instead it focused on improving the services through its IPTV/FTTx service offerings.

With its IPTV/FTTx service offering, which has had strong customer uptake in the recent past, TU has managed to support the segment's revenues. The company's margins might get pressurized with the rollout cost of IPTV/FTTx services in the near term; however, the services will portend well for TU's performance in the long term. The following table shows TU's wireline segment's revenue growth and EBITDA margin.

Q1-13

Q2-13

Q3-13

Q4-13

Revenue Growth (YoY)

3%

6%

3%

3%

EBITDA Margin

28%

25%

26%

25%

Source: Company's Quarterly Earnings Results

The following graph shows how the incremental wireline segment's line losses have been moderating in the recent past.

Source: Company's Quarterly Earnings Report

Airwaves Spectrum Auction
TU, in its attempt to further strengthen its wireless segment operations, acquired 31 licenses for $1.1 billion earlier this year in February. TU, with the acquired licenses and improved infrastructure, will help the company strengthen its coverage and services. TU's CEO recently said, "Today we deliver 4G LTE to 80 percent of Canada's population. The addition of this 700MHz spectrum will enable us to expand our LTE coverage into rural areas, extending TU' national 4G LTE network to 97 percent of the population well in advance of the auction's build requirements."

I believe the growth investments by TU will improve the company's operations, its subscriber base and top line numbers.

Investors Returns and FCF Base
The company has been sharing its successes with shareholders through dividends and share buybacks. TU offers a solid dividend yield of 3.80%. The company has a plan to repurchase $500 million worth of common stock, approximately 2.2% of its current market capitalization. The share buybacks will positively affect TU's EPS growth rate and magnify its ROE.

The dividends offered by the company are sustainable, despite the recent pressures on TU's cash flows, mainly due to capital investments to expand the capacity, services and coverage of its advanced broadband networks, as the growth investments will positively affect TU's services and cash flows in the long term. The capital returning programs of TU in general and share buyback plan in particular will improve its earning. The following graph shows the FCF's decreasing trend in all quarters of 2013, due to investment spending to improve infrastructure.

Source: Company's Quarterly Earnings Report

Balance Sheet - Strong
TU has a strong balance sheet, with a debt-to-equity of 0.93x, lowest among the peers. Also, the company does not have any significant debt maturities in the near future. The company has $2 billion in available liquidity, and holds investment grade credit ratings. The following table shows debt-to-equity comparison between RCI, TU and BCE.

Company

Debt to Equity

TU

0.93x

RCI

2.72X

BCE

1.41X

Source: Morning Star

Price Target
I have calculated a price target of $41 for TU. I have used cost-of-equity 9.20%, after tax cost of debt 3.75%, WACC of 6.5% and terminal year growth rate of 1.5% for my price target calculations. Based on my price target of $41, the stock offers a potential price appreciation of 11%.

2015

2016

2017

Terminal Value

FCF (In $-Millions)

1,541

1,674

1,738

$35,271

Present Value of FCF (In $-Millions)

1,447

1,476

1,438

29,199

Source: Calculations

Total Present Value of Cash flows and Firm= $33,560 million

Market Value of Debt = $8,040 million

Market Value of Equity = $33,560 - $8,040

= $ 25,520 millions

No. of Shares Outstanding = 623 million

Target Price = $25,520/623

= $41

Conclusion

TU is well positioned in the highly competitive Canadian Telecom Industry, and the wireless segment remains its main growth driver. The company's IPTV/FTTx services will portend well for its earnings growth in the future. The company's capital and growth investments are likely to benefit its operations and market position in the future. Moreover, the stock offers a solid dividend yield of 3.8% and the stock offers a potential price appreciation of 11%, based on my price target of $41. Due to the above mentioned factors, I am bullish on the stock.

Source: Telus Secures Position As Fast Growing Telecom Company, Earns Bullish Rating