Telus Corp.: A Formidable Pick For Dividend Growth Investors

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About: TELUS Corporation (TU)
by: Dilantha De Silva
Summary

Telus shares have declined marginally in the last 12 months.

Telus is poised to grow for many years to come, and its recent capital investments are projected to provide the firm with competitive advantages in the near future.

Shares yield over 4.5% at the current market price, and trade at a discount to my fair value estimate.

Investment thesis

Telus shares (NYSE:TU) have declined marginally over the last 12 months, but have continued to provide an attractive dividend yield to investors.

(Source – Morningstar)

Telus is set to grow for many years to come, driven by its strategy to improve the quality of its services offering. The company has invested a significant amount to build the necessary infrastructure to shift from copper cables to fiber-to-the-home technology. I expect this to provide competitive advantages to the firm, and a much higher market penetration by the end of next 5 years. Shares yield over 4.5% at the current market price, and are trading at a discount to my fair value estimate.

Company overview & business strategy

Telus is one of the big three wireless services providers in Canada, accounting for almost 30% of the total market. Telus operates under two different business segments.

  1. Wireless
  2. Wireline

Over the last several years, the wireless segment has continued to gain traction, and has been the main driver of customer connections growth in this period.

https://static.seekingalpha.com/uploads/2019/3/10/49736731-15522512632963326.png

(Source - Investor presentation)

Telus provides various solutions to its customer base in Canada, including personal, business, and healthcare solutions.

Personal solutions

Business solutions

(Source – Company website)

The primary business strategy of Telus is to acquire a higher customer base by providing a top-quality service, and the company has already initiated several measures to improve the overall customer experience.

The successful completion of the shift to Telus PureFiber is expected to provide customers with a seamless browsing experience, and will help the company consolidate its market share meaningfully. The shift from its copper infrastructure to fiber-to-the-home technology (FTTH) is expected to increase browsing speeds significantly, and the management confirmed 60% of the project is already complete, and the completion ratio is expected to be over 70% by the end of 2019.

(Source – Company website)

I believe the strategy to provide higher quality products and services will provide competitive advantages to Telus over the next couple of years, which should help the company charge premium prices for its solutions. This will drive company earnings higher, and I expect Telus to build on its economic moat, driven by superior quality products and a significant market share in its key markets.

Telus has introduced a variety of products and solutions to cater to the growing demand for online healthcare services as well, which is another business segment that is expected to gain traction rapidly in the near future. The demand for virtual healthcare solutions has skyrocketed in the recent past, and this provides a robust growth opportunity for Telus, as the necessary infrastructure to provide virtual healthcare services to Canadians are already in place for Telus.

Babylon by Telus Health is one such mobile app developed by Telus to allow its users check their symptoms, consult a doctor virtually, and get a valid prescription.

(Source – Company website)

In addition to this mobile application, Telus has revealed two more applications to cater to niche segments.

  1. Telus Baby Health
  2. Telus Healthy Living Network

Telus LivingWell Companion is an innovative device designed and marketed by Telus with a focus on securing safety of individuals.

(Source – Company website)

These innovative products and services are expected to drive the popularity of healthcare solutions provided by Telus, and the company is focused on providing a bundled service to its customers, which should lead to higher switching costs in the future.

Financial statements evaluation & valuation

The last couple of years have been tremendous for Telus from a topline perspective, and the company has been able to grow its revenue at a stellar rate in this period. The recent rise of internet based concepts such as internet of things (IOT), internet of medical things (IOMT), and virtual healthcare facilities have all contributed equally to the revenue growth of the company. An increasing number of consumers are willing to pay premium prices to obtain top-notch, reliable wireless services, and this has been another catalyst for Telus’ revenue growth.

On the other hand, the rise of online content streaming has played its part as well, by being an obstacle to grow the wireline business segment but a driver of growth for the wireless segment. I expect company revenues to grow at a range of 5-6% over the next 5 years, as I expect a higher market penetration in the forecast period driven by a higher quality service.

(Source – Author prepared based on data from company filings)

Capital expenditures have soared in the recent past, mainly driven by investments to build the necessary infrastructure to roll out the fiber-to-the-home technology. This significant uptick in capital spending is expected to subdue beyond 2019, and the company has already carried out the bulk of these infrastructure development plans. Analysts believe that the company might not be interested in expanding the fiber network beyond 2019, as incremental earnings are not expected to grow at a meaningful rate as a result of further investments.

(Source – Author prepared based on data from company filings)

Telus has been able to keep the post-paid churn at considerably lower levels than it was 5 years back, and this adds a degree of certainty for company earnings.

(Source – Investor presentation)

The wireless subscriber base has grown over the last 5 years, and this will be a key driver of growth in the next 5 years as well. I expect the wireless subscriber base to grow at a steady rate in the next 5 years.

(Source – Investor presentation)

As the focus of this analysis is to assess Telus’ suitability for dividend growth investors, I have placed a special emphasis on identifying whether dividend distributions of Telus can be considered safe.

The balance sheet of the company is strong, and despite significant capital investments over the last 4 years, Telus has been able to keep its debt levels at a manageable range. Generally, high-growth projects result in unfavorable skews in the capital structure for dividend investors, but this is certainly not the case with Telus.

(Source – Author prepared based on data from company filings)

Telus has been generating sufficient free cash flow to continue distributing wealth to shareholders, fund capital projects, and to service its debt. As capital expenditures are expected to decline in the coming periods, I expect free cash flow to improve meaningfully over the next 5 years. However, further capital-intensive projects might come along the way as technological developments are dynamically changing the industry.

Free cash flow vs. dividends paid

(Source – Author prepared based on data from company filings)

In recent periods, Telus has not been able to cover its dividend distributions with free cash flows, which might ring a false alarm to dividend growth investors. As pointed out earlier, capital expenditures remained at elevated levels in this period, and free cash flows are expected to grow in the next 5 years, which should provide the required cover for dividend payments.

Telus has paid dividends for the last 19 years consecutively, and despite a few setbacks, has been able to grow dividend per share in this period. I believe the next 5 years will continue to be dividend growth years, or, at least, years in which the company will be able to easily maintain the current level of dividend per share.

Dividend history

(Source – Seeking Alpha)

Overall, Telus is set to report stellar performance in the next 5 years, and its dividend is safe and should continue to grow in this period. Telus has consistently earned an attractive level of return for its equity investors, and the trend should continue as the company moves into a promising future.

(Source – Morningstar)

Telus is currently trading close to the lower end of the consensus analyst estimate, and the median estimate provides an upside of 7% from the current market price.

(Source – CNN)

To arrive at a fair value estimate for Telus, I have used a dividend discount model, which falls in line with the purpose of this analysis, which is to evaluate Telus as a candidate for a dividend growth portfolio.

Major assumptions used in this analysis are listed below.

  1. Revenue growth of 5.5% in the next 5 years, and 1.5% in perpetuity
  2. Beta of 0.9 in the next 5 years, and 1 in perpetuity
  3. Return on Equity of 15% in perpetuity
  4. Payout ratio of 77% in the next 5 years, and 90% in perpetuity

With these assumptions, I arrive at a fair value estimate of $40.77 for Telus, and this presents an upside of 14% from the current market price.

(Source – Author’s calculations and assumptions)

At the current market price, shares yield over 4.5%, and this provides an attractive entry point for dividend growth investors. The expected convergence of the share price with its intrinsic value will provide a handsome capital appreciation return for investors as well.

Risks & Challenges

Intense competition remains the primary risk of investing in Telus, and higher competition might result in price wars, which would negatively affect profit margins of the company. The wireline business segment is particularly expected to come under the threat of its competitor activities, and this might result in lower revenues from this segment in the future.

Regulatory risks are present for Telus as well, and the company might come under pressure if the Canadian government comes up with tariffs and/or any other measure to curb imports of Chinese products.

The "cut the cord" movement might also present some risks to the wireline segment of Telus, but on the other hand, Telus is trying to mitigate this risk by providing a high-quality wireless service which should encourage more customers to sign-up with their network.

Conclusion

Telus shares are attractively priced for dividend growth investors, and I expect dividends to be hiked multiple times in the next 5 years. Shares are trading at a discount to my fair value estimate, which provides a necessary margin of safety for dividend growth investors to go long Telus.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.