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TELUS Corporation (TU)

Founded in 1993, Telus (TU) is one of Canada’s major telecom businesses and the country's largest wireless provider. In fact, the firm has roughly one third of the national wireless market and over 40% of the internet market. Telus is especially dominant in Western Canada and serves a total of 13.1 million customers:

  • Wireless: 8.9 million customers, up 3.8% in 2017
  • Internet: 1.8 million customers, up 5.3% in 2017
  • Residential Access Lines: 1.3 million customers (traditional phones), down 5.5% in 2017
  • Cable TV: 1.1 million customers, up 3.7% in 2017

Telus reports its internet, phone, and cable TV businesses as part of its wireline (physical connection) segment, which accounted for 43% of sales and 35% of adjusted EBITDA in 2017. The company also operates data centers which offer cloud computing solutions (wireline data), as well a pharmacy, medical records, and medical claims management under its subsidiary Telus Health, which is also listed as part of the wireline segment.

Telus' wireless segment generated 57% of revenue and 65% of adjusted EBITDA. In 2017, the wireless business was the most important driver of the company's profits with 5.2% adjusted EBITDA growth compared to 4% for the wireline business. That slower growth rate was due to the continued decline in Telus' home phone business, a secular trend that most global telecom companies are facing. 

Business Analysis

Telus has about 21% market share of Canada's $62 billion telecom industry, which is growing around 3% a year. The company used to be a regional telecom player, but in 2000 it acquired Clearnet Communications for $6.6 billion. This deal transformed Telus into a blossoming national wireless company while also broadening the range of bundled services it could offer.

In other words, acquiring Clearnet positioned Telus to go head-to-head with major rivals Bell Communications and Rogers Communications. The company’s efforts to build out its mobile-phone presence across Canada in the years following the deal have been very successful.

As you can see, Telus has done an admirable job of growing consistently over time, in both its wireline and wireless business.
Source: Telus Annual Report
That's in contrast to major U.S. telecoms like AT&T (T) and Verizon (VZ) who have experienced top line growth challenges in recent years stemming from a fiercely competitive wireless market and the continued decline in legacy landline businesses.

Telus has been undertaking a multi-year restructuring that evolves its business model away from the declining landline business (up to 45% of customers in certain provinces have no landline phone service) and towards faster-growing internet, pay-TV, and data businesses.

For example, the company's PureFibre high speed internet is available in over 100 cities with coverage of 3 million households. Meanwhile, Telus has been making opportunistic bolt-on acquisitions, including over $400 million in deals in 2017, to help grow its data business, which includes Telus International and Telus Health. 

Telus is also getting into cloud computing with the 2017 launch of its network-as-a-service, or NAAS, business. All told, Telus' diversification into data businesses has been successful so far, with 32% of 2017 revenue now coming from this fast-growing business.
Source: Telus Annual Report
However, the company's main growth driver is still its wireless business. Telus has invested heavily ($2 billion to $3 billion per year in capex, or over 20% of sales) into expanding its 4G LTE network which today covers 99% of Canada's population. In Canada, Telus is analogous to Verizon in the U.S. with the best national wireless network.

It's also the fastest wireless network according to surveys by PC Magazine, Ookla Speedtest, and Opensignal. In addition, Telus is known for having the best customer service in the industry with six straight years of the least customer complaints in the Annual Commission for Complaints for Telecom-television Services (CCTS) study.

This combination of the nation's best wireless network and top notch customer service has resulted industry-leading low monthly churn numbers (i.e. high customer retention). 
Source: Telus Annual Report
In fact, for the last four years Telus has averaged less than 1% monthly churn rates. In 2017, the telecom's monthly churn averaged 0.9%, which was a record low for the company. 

Low churn helped drive average revenue per user, or ARPU, up 3% in 2017, and Telus' lifetime revenue per subscriber also increased from $5,400 to $6,000.

To retain its lead in wireless, the company is testing out 5G technology in its Vancouver R&D facility and has thus far achieved wireless download speeds of 1 to 2 Gigabits per second. By 2019, global 5G standards are expected to be finalized. 

Telus expects to quickly build out a leading 5G wireless network that will allow it to hopefully dominate not just phones, but also wireless internet and devices connected to the so-called internet of things, such as driverless cars. Telus expects to offer wireless broadband in homes as soon as this year, per The Wall Street Journal.

At the end of the day, consumers and businesses value the reliability of Telus' wireless network and its reputation for superior performance. As long as Telus continues to invest in its leading network coverage and architecture, the company should continue maintaining a massive base of customers. Disrupting Telus' base of customers would be almost impossible barring a revolutionary change in network technologies.

For one thing, growth in the number of new wireless subscribers has slowed considerably with smartphone adoption now being widespread. With new customer growth hard to come by, the industry has consolidated to become more productive and expand coverage. 

Telus' relatively large subscriber base (about 9 million wireless subscribers) provides it with the cash flow needed to support and enhance its existing wireless network. Potential new entrants lack the subscriber base needed to fund a nationwide wireless network and acquire spectrum licenses, effectively keeping them locked out of the market.

Trying to win subscribers over from Telus would be extremely costly and impractical for almost any newcomer. It’s a lot easier to maintain an existing large base of subscribers in a mature market than it is to build a new base from scratch.

Simply put, new entrants lack the capital, spectrum, and subscriber base to effectively compete with any of the big three carriers in the Canada. In addition to the industry’s high barriers to entry, the wireless communications market is also appealing because its services are non-discretionary in nature.

As previously discussed, Telus' monthly postpaid churn rate has averaged less than 1%. The majority of the company’s revenue is also recurring because consumers and businesses have a continuous need to communicate and use data, even during recessions. As mobile and broadband usage continues growing with increased consumption of data and video, Telus' wireless network should become increasingly valuable

The company's ability to continue protecting and growing its wireless, internet, and television customer base is why management is confident that Telus can achieve some of the industry's best growth rates, including 4-6% revenue growth and 4-7% adjusted EBITDA growth in 2018.

That in turn should allow Telus to continue its track record of delivering very strong and sustainable dividend growth. Since 2011, Telus has been growing its dividend by 10% per year. The company targets a 65% to 75% payout ratio and plans to achieves 7% to 10% annual dividend growth through at least 2019. 
Source: Telus Annual Report
Despite Telus' combination of yield and income growth, investors need to understand that there are still several risks facing the company in the next few years. 

Key Risks

First, it's important to point out that as a Canadian company, Telus pays its dividend in Canadian dollars. This creates some currency risk in that a stronger U.S. dollar might decrease the effective dividend amount for American shareholders, at least in the short term (each quarterly dividend is converted from Canadian dollars to U.S. dollars when it is paid, based on prevailing exchange rates).

In addition, like all Canadian stocks, Telus investors will face a 15% foreign dividend tax withholding, except in retirement accounts such as IRAs and 401Ks. Tax treaties between the U.S. and Canada allow U.S. investors to potentially recoup this withholding, but it can be a complicated and lengthy amount of paperwork at tax time.

There are several company-specific risks to consider as well.

Telus, Rogers, and Bell are Canada's three national carriers who command around 90% of the wireless market in Canada ( there are also five regional players). However, in recent years the Canadian Radio-television and Telecommunications Commission, which regulates the industry, has become concerned about a lack of competition.

This has resulted in some unfavorable developments for Telus, including a 2015 rule change that capped wireless contracts at two years (previously they had been as long as three years). In addition, the commission is considering forcing major telecoms to reduce roaming fees, which would pressure their margins somewhat.

A major new entrant could also disrupt the Canadian telecom industry’s favorable structure. In 2012, for example, the industry grew fearful that Verizon was planning to buy wireless company Wind Mobile in an effort to enter Canada and challenge the three major incumbents. Valuation multiples quickly dropped between 7% and 27% for Telus, Bell Communications, and Rogers.

While the potential threat from Verizon never materialized, cable operator Shaw Communications (SJR) ended up acquiring spectrum-rich Wind Mobile for $1.6 billion in March 2016, marking its entry into the wireless market in an effort to better compete with Telus’ bundled services (Shaw can now offer television, wireless, and internet in major urban areas such as Ontario, Alberta, and British Columbia).

Here’s what Shaw CEO Brad Shaw said in an interview, according to TheTelecomBlog.com:

“Wireless was a missing piece. Now we’re on the same page, we’re at the same level … and we’ve improved our competitive position in Western Canada just by doing this deal, let alone the opportunity in the East.”

Shaw rebranded the wireless business Freedom Mobile and is positioning it as a lower-priced option compared to the major three operators (driven by its inferior service quality). Regardless, Shaw is looking to play the role of disruptor and is now the fourth telecom company to cover the entire length of Canada.

Should Freedom Mobile improve its network coverage and quality enough to experience strong growth, the big three incumbents could face subscriber growth pressure and margin compression over the coming years.

The good news is that the Canadian wireless market continues experiencing healthy growth, providing a little more elbow room, and Telus continues to report sold network performance and customer service results, as demonstrated by its subscriber growth and churn rates.

Only time will tell if Telus’ superior network quality and customer service will allow it to continue enjoying its industry-leading churn rate and average revenue per user, or if it will ultimately face the greatest pressure to lower prices in an effort to close the gap with lower-priced competition. That's arguably the biggest risk factor investors need to monitor. 

Another threat to Telus' wireless business is the potential for very expensive bidding to acquire 5G wireless spectrum. With just three major players in the market, if Telus and its major peers get into a bidding war and overpay for this spectrum, than their capex costs could soar, crimping profitability and limiting how fast they could grow their dividends.

Further capex concerns might come from the wireline business, especially in Western Canada where Telus has an effective duopoly with cable giant Shaw. Telus is at a competitive disadvantage today because Shaw has a wider and more modern network of fiber optic lines compared to Telus' large network of aging copper cables.

In order to grow its wireline business in internet and cable TV in the western part of the country, Telus may be forced to invest more heavily. That, combined with the expense of building out a 5G wireless network, might stretch its balance sheet.

Fortunately, the company still enjoys a BBB+ credit rating, which management says it plans to maintain. That's thanks to its long-term plan to lower its net debt/EBITDA ratio from 2.7 to around 2.0 to 2.5. In the meantime, the company continues to enjoy strong access to long-term and low-cost debt.

Finally, Telus's pay-TV business, while still growing, faces the same cord-cutting threat as in the U.S. Here the cable TV/satellite TV industries have been steadily losing customers for years.

Telus has responded with its own innovations including the Optik TV app, which allows subscribers to watch live TV, set recordings, and access its On Demand library on a smartphone, tablet or computer.

It's also launched Pik TV, which provides customers with access to 23 basic local and regional cable channels and a choice of five specialty channels, as well as sports and movie theme pack options, through a self-install media box. This is a cheaper cable TV option that Telus hopes can compete effectively with on demand TV alternatives such as Netflix.

However, there is ultimately no guarantee that Telus will be able to keep growing its pay-TV business, the infrastructure for which it's spent significant amounts of money on in recent years.

In fact, the growth rate of the company's TV subscriber base has already slowed considerably. That's both due to cord cutting pressures as well as the fact that Canada's pay-TV market is relatively smaller and saturated.
Source: Telus Investor Presentation

Closing Thoughts on Telus

As Canada's largest wireless provider, and one of the most dominant telecoms in the country, Telus enjoys large economies of scale and a predictable recurring revenue business model. 

The company has only reinforced its competitive advantages by continuing to upgrade its wireless network and offer relevant services as consumers' needs evolve. This has helped Telus achieve the industry's best customer service reviews and retention rates, as well as one of the best lifetime revenues per subscriber. 

And despite some of the potential challenges facing the telecom sector (market saturation, a potentially disruptive fourth major player in Freedom Mobile), Telus has proven itself to be capable of adapting well over time. The business has been a reliable source of safe and growing dividends over the years, and that is unlikely to change anytime soon. 

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