DBRS Places TELUS Corporation Under Review with Negative Implications

DBRS Limited (DBRS) has today placed the Issuer Rating, Notes rating and Commercial Paper rating of TELUS Corporation (TELUS or the Company; rated A (low), A (low) and R-1 (low), respectively) and the Senior Debentures rating of TELUS Communications Inc. (rated A (low)) Under Review with Negative Implications. The rating action follows the Company’s announcement that it has secured 15 megahertz (MHz) of AWS-3 (advanced wireless services) spectrum for $1.5 billion. While DBRS recognizes the importance of investing sufficiently in spectrum over the long term, the Negative Implications of the review status reflect DBRS’s concern that this particularly large spectrum purchase will likely be financed with debt and weaken the financial risk profile of TELUS well beyond its previously stated policy range (net debt-to-EBITDA of 1.5 times (x) to 2.0x) and levels appropriate for the current rating categories. Operationally and financially, DBRS expects TELUS will continue to perform well and deliver mid-single digit growth in EBITDA to approximately $4.4 billion in 2015, based on the Company’s growing subscriber bases across both wireless and wireline, increasing revenues per user and ongoing network expansion.

In its confirmation press release on July 7, 2014, DBRS stated that it believed TELUS’ priority going forward would likely be to de-leverage to just under 2.0x net debt-to-EBITDA (pension expense adjusted to pre-2013 IAS 19) by the end of 2015. As of the end of 2014, this metric stood at 2.25x, and DBRS is now concerned that it could increase further to approximately 2.5x by the end of the year, more consistent with the BBB (high) and R-2 (high) rating categories. (Note: this metric ranged from 1.7x to 1.9x between 2010 and 2013.) This is based on DBRS’s belief that while TELUS has one of the strongest balance sheets in its industry, the Company may now use its operating cash flow and raise incremental debt in 2015 to fund its capital investment (including spectrum purchases) and returns to shareholders, resulting in net debt of approximately $11.5 billion. The debt balance could be even higher should TELUS win spectrum in the 2500 Mhz auction next month; however, DBRS notes the cost of spectrum in this auction is expected to be significantly lower than the most recent one.

In terms of other key credit metrics, interest coverage declined to 9.65x in 2014 from 11.03x in 2012, despite declining interest rates. Over the same period, debt-to-capital increased to 55.8% from 46.4%, and cash flow-to-debt deteriorated to 0.36x from 0.48x. Of particular note is the weakening trend in free cash flow (after dividends and before spectrum purchases and changes in working capital), which declined from a reasonably strong $443 million in 2012 to only $150 million in 2014, primarily because of the increasing capital intensity of the business and high dividend growth. However, DBRS notes that TELUS has guided for increased cash flow in 2015.

Notwithstanding the Company’s prospects for growth in earnings over the near to medium term, DBRS questions TELUS’ willingness and ability to deleverage toward its previously stated leverage target within a reasonable time frame (i.e., two years), given its capital investment plan and anticipated returns to shareholders. In its ongoing review with management, DBRS will focus on an update of the Company’s business strategy going forward (including capital investment and spectrum purchases) and its financial management intentions (including dividend distributions, share repurchases and financing sources) in order to determine whether a downgrade is warranted. DBRS aims to receive clarity from TELUS management on the aforementioned issues in the coming weeks in order to resolve the Under Review status of the ratings.

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

The related regulatory disclosures pursuant to the National Instrument 25-101 Designated Rating Organizations are hereby incorporated by reference and can be found by clicking on the link to the right under Related Research or by contacting us at info@dbrs.com.

This rating is endorsed by DBRS Ratings Limited for use in the European Union.

The applicable methodologies are Rating Companies in the Communications Industry and DBRS Criteria: Commercial Paper Liquidity Support for Non-Bank Issuers, which can be found on our website under Methodologies.