DBRS Confirms TELUS’s Ratings at A (low) and R-1 (low), Stable Trend

DBRS has today confirmed the ratings of TELUS Corporation (TELUS or the Company) at A (low) and R-1 (low) and the ratings of TELUS Communications Inc. at A (low). The trends are Stable. The confirmation reflects the Company’s continued diversified business risk profile in Canada, with a strong focus on the wireless and data segments, relatively stable residential and enterprise fixed-line operations, strong generation of cash flow from operations and reasonable balance sheet. The Company’s cash flow from operations gives TELUS the capability to embark on a period of higher investment in its network in 2009 without impairing its balance sheet. However, DBRS cautions that the operating environment remains highly competitive, which, along with the current economic downturn, is likely to affect TELUS’s EBITDA growth in the near term.

TELUS continues to benefit from diversification, with its exposure to wireless and wireline segments both regionally in its incumbent territory and on a national basis. However, DBRS notes that TELUS continues to experience pressure from competition and upfront costs to acquire subscribers in its growth areas. These factors, in addition to some softness due to the current economic environment, are expected to limit TELUS’s EBITDA growth in 2009 and possibly into 2010. DBRS believes that these factors, if not addressed, could reduce the Company’s medium-term growth prospects and ultimately its competitive positioning.

Despite lower EBITDA growth expected in 2009, DBRS does expect EBITDA to improve modestly in 2009 to approximately $3.8 billion (on DBRS’s basis which excludes restructuring and pension expenses) as wireless and data growth and cost-cutting efforts are expected to more than offset competitive and economic factors and higher customer acquisition costs.

TELUS is also investing in its operations in 2009 (both operating expenses (opex) and capex) to acquire customers and position its network for future growth. The opex investments will be in higher customer acquisition costs, other costs in wireless and in TELUS TV and in enterprise services, where upfront costs are incurred before revenue begins to be realized.

TELUS’s wireless segment, which accounts for more than 53% of its total EBITDA, is expected to continue to drive EBITDA growth in 2009, albeit at a more modest rate given the competitive and economic environments and higher acquisition costs, with a focus on increasing smart-phone activations. These competitive and economic factors have driven churn rates slightly higher and average revenue per user (ARPU) lower as voice ARPU pressure has not been made up with data ARPU growth. DBRS believes that some of the economic softness on ARPU may have been more acute for TELUS given that (1) approximately 11% of its subscribers are Mike subscribers (in industries and regions that have been more affected by the economy), who use the iDEN (integrated digital enhanced network), (2) it has signifigant exposure to the western Canadian economy; and (3) penetration of its Koodo Mobile service has increased. Despite these factors, wireless EBITDA margins currently remain healthy for TELUS at about 43%.

Going forward, DBRS expects TELUS, like the other incumbent wireless carriers in Canada, will face new wireless competitors (facilitated by the AWS (advanced wireless spectrum) auction in 2008). This is in addition to robust competition from the other two national carriers. As a result, DBRS expects the competitive environment to intensify in the Canadian wireless market as entrants begin to deploy services over the next year. This could pressure TELUS’s wireless operating metrics such as churn and ARPU along with its EBITDA margins. DBRS notes that if the new competitors choose to compete on price, TELUS does have flexibility with its Koodo Mobile service to allow it to compete for price-sensitive subscribers.

With the advent of new wireless competitors, TELUS is embarking on a joint venture with another CDMA (code division multiple access) operator to overlay a national HSPA (high-speed packet access) network. DBRS believes this investment, in a rather efficient manner, will better position the Company competitively (against both the current and new entrants) and put it on a smoother migration path to the 4G (fourth-generation) wireless standard LTE (long-term evolution) in the future.

From a wireline perspective, TELUS continues to balance growth in services, such as high-speed Internet and enterprise data, against access-line erosion, which pressures local and long-distance revenue. TELUS also continues to invest in its wireline network to enhance its data speeds and allow it to deploy video offering (TELUS TV) so it can bundle services to its subscribers and more effectively compete with the cable companies. TELUS’s enterprise data business, which also remains highly competitive, continues to gain new contracts. These contracts are dilutive to free cash flow initially as opex and capex are incurred before revenue begins to be realized. TELUS’s acquisition of Emergis Inc. (Emergis) in 2008 also helped the Company bolster its key vertical strategy in enterprise services with the addition of Emergis’s presence in the health-care sector.

DBRS notes that from a financial risk perspective, TELUS continues to have a reasonable balance sheet and its cash flow from operations allows it to undertake the investments required in its operations while continuing to pay a reasonable dividend. Although DBRS expects free cash flow to be lower in 2009 as a result of higher capex, it should be more meaningful in 2010 once these investments have been completed. However, DBRS would become concerned should free cash flow become negative in 2009 or not return as expected in 2010 in conjunction with higher debt levels.

Overall, DBRS believes that TELUS’s ratings are well placed at the current level, with the expectation of increased competition in wireless and ongoing competition in its wireline operations. DBRS believes that TELUS will continue to balance cash flow from operations between investing in its operations and in shareholder returns while maintaining leverage within its targeted range (net debt-to-EBITDA of between 1.5 times and 2.0 times). Although DBRS notes that TELUS is currently at the upper end of this range (1.9 times reported, 1.95 times using DBRS’s calculation), higher free cash flow and EBITDA from its investments undertaken in 2009 should help to keep TELUS within this targeted range in 2010. However, DBRS notes that should competition unfold that pressures TELUS’s business risk profile along with pressure on cash flow from operations, higher leverage and shareholder returns, these factors could put downward pressure on its ratings.

Notes:
All figures are in Canadian dollars unless otherwise noted.

The applicable methodology is Rating Telecommunications, which can be found on our website under Methodologies.

This is a Corporate rating.