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

DBRS has today confirmed both the long- and short-term ratings of TELUS Corporation (TELUS or the Company) at A (low) and R-1 (low), respectively, and the long-term rating of TELUS Communications Inc. at A (low). The trends are Stable. The confirmation reflects the Company’s diversified business risk profile, with a focus on the growing wireless and data segments, a competitive but relatively steady residential and enterprise fixed-line operation, strong cash flow from operations generation and a reasonable balance sheet.

TELUS’s financial position has allowed it to undertake periods of higher investment in its wireless and wireline businesses, which in DBRS’s view has enhanced its position in these highly competitive markets. Examples include: (a) the investment in its wireless High Speed Packet Access (HSPA+) network deployment (completed in November 2009; this included jointly built national coverage with Bell Canada) to better compete against the two larger national wireless incumbents, regional wireless carriers and new wireless entrants; and (b) its ongoing fixed-line network investments (including fibre deployments and DSL evolutions such as ADSL, ADSL2+ and VDSL), allowing it to offer more competitive data speeds and IP video services (branded Optik TV) to better compete with cable operators in its incumbent territories. However, DBRS notes that now that these new networks have been deployed, TELUS faces significant customer acquisition and retention costs, which could pressure its EBITDA margins and require additional capex in the short term.

While DBRS expects TELUS to continue to operate in a competitive landscape for all of its services, its network investments should eliminate or at least mitigate the advantages that the Company’s competitors have had in the past with their networks. In fact, DBRS notes that TELUS may have a near-term advantage with its HSPA+ wireless network (which offers theoretical download speeds of up to 21 Mbps), with 93% population coverage. Furthermore, TELUS recently announced that with Dual Cell technology it plans to double these speeds to 42 Mbps by early 2011. This, along with obtaining the very latest HSPA+ handsets and devices and ongoing marketing and retention efforts, should ensure that TELUS gets its share of the growth in the Canadian wireless market in terms of post-paid subscribers and smart phones. The uptake of smart phones (which DBRS estimates now account for over 25% of TELUS’s total post-paid subscribers) is expected to drive significant wireless data growth for the Canadian carriers going forward. This is important as voice services continue to be commoditized – as seen in the meaningful pressure on TELUS’s voice ARPU (average revenue per user) in 2009 – with pricing pressured by new wireless providers entering (or about to enter) the wireless market in Canada. Notably, to date the new entrants have focused on unlimited-style pricing plans, with the incumbents likely to match this type of pricing with their new or existing flanker brands. DBRS believes that the impact of smart-phone growth (meaningfully higher ARPU but initially dilutive with acquisition and retention spending) and competition-driven voice ARPU pressure will put some strain on TELUS’s wireless EBITDA margins in the near term. However, the EBITDA margin should remain at or above the 40% level over the medium term, which is healthy for a North American wireless carrier.

In the wireline segment, DBRS notes that TELUS continues to face strong cable competition in its incumbent territories for residential and small and medium-sized business customers, in addition to technology substitution (wireless for wireline). Both of these factors continue to reduce TELUS’s access lines, albeit at a relatively stable pace of 5% to 6% per year. DBRS believes that by adding video services to its bundle (both IPTV through Optik TV and satellite service for other regions), TELUS should be better equipped to compete with cable by offering its current and potential subscribers up to five services as part of a bundle. This should reduce some of the voluntary access-line erosion that occurs when customers leave for a competitor. However, DBRS notes that, as in the wireless business, adding residential video and high-speed Internet subscribers requires an initial investment in terms of acquisition costs (especially in video). Despite some success in the national enterprise sector, this market remains highly competitive and vulnerable to technology changes as business customers migrate over time to IP-based services. Therefore, as TELUS continues to load residential video subscribers and lose high-margin voice services, its EBITDA margins could experience further pressure. However, with further efficiency initiatives, they should remain at the mid-to-upper 30% level, which is reasonable for a North American telco with a large enterprise business.

In light of the above dynamics in TELUS’s wireless and wireline businesses, including continued growth in wireless, data and video, ongoing competition and technology substitution, along with higher customer acquisition and retention expenses, DBRS expects EBITDA to improve modestly over the next couple of years, including an estimated $3.8 billion of EBITDA for 2010 (on DBRS’s basis, which is before restructuring and pension expenses). This level of EBITDA, along with capex returning to more normal levels (high teens as a percentage of revenue versus nearly 22% in 2009), is expected to more than cover the Company’s higher dividend payout ($2 annualized per share for at target payout range of 55% to 65%, up from the previous 45% to 55%). This should result in healthy free cash flow levels of between $300 million and $400 million per year over the next few years. After the heavy investments made in 2009, DBRS expects EBITDA growth and higher free cash flow to help to reduce TELUS’s leverage in the coming years, taking it toward the mid-point of its 1.5-2.0 times net debt-to-EBITDA target, or closer to 0.40 times cash flow-to-debt.

Going forward, DBRS expects the operating environment to remain competitive, but believes that it should be manageable for TELUS, especially with its network investments which, in the case of wireless, have given it a competitive advantage, and in wireline, should quickly close the gap with competitors. This manageable business risk profile is expected to be accompanied by a reasonable balance sheet. Should these expectations for TELUS change as a result of competitive or regulatory initiatives (including possible liberalization of foreign ownership restrictions in Canada) or higher leverage and shareholder returns, the result could put pressure on the Company’s ratings in the future.

Note:
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 (Telecom/Media/Technology) rating.