DBRS Morningstar Downgrades TELUS Ratings, Changes Trend to Stable

DBRS Limited (DBRS Morningstar) downgraded TELUS Corporation’s (TELUS or the Company) Issuer Rating and the rating of the Company’s Notes to BBB from BBB (high). DBRS Morningstar also downgraded the rating of TELUS’ Commercial Paper rating to R-2 (middle) from R-2 (high) and the rating of TELUS Communications Inc.’s Senior Debentures to BBB from BBB (high). All trends have been changed to Stable from Negative. The rating actions reflect the significant increase in debt and therefore financial leverage that has been taken on to finance an accelerated acquisition expansion phase in TELUS’ non-telecommunication businesses, higher-than-expected spectrum costs, and an accelerated network spending program, while maintaining high-single digit growth in shareholder returns. The combined increase in debt to fund these activities has outpaced the growth in internally generated cash flows since the beginning of 2021. The Stable trend reflects DBRS Morningstar’s view that TELUS is soundly place in the new rating category of BBB, even if the Company does not endeavour to deleverage from its current level.

As of YE2020 results, DBRS Morningstar noted leverage was materially higher than initially contemplated, reflecting both the Coronavirus Disease (COVID-19) pandemic, but also the impact and acquisition activity. TELUS was subsequently put on Negative trend on August 18, 2021, reflecting rising debt balances post the 3500-megahertz (MHz) spectrum auction, a longer period of balance sheet deleveraging than initially contemplated. In DBRS Morningstar’s view, the Company would have to execute to precision on its business plan in order to achieve industry-leading earnings growth. In June 2022, DBRS Morningstar confirmed TELUS’ Issuer Rating at BBB (high) and maintained the Negative trend post the announcement of a definitive agreement to acquire LifeWorks, Inc. (LifeWorks) for approximately $2.3 billion and the assumption of $600 million in debt. At that time, the confirmations acknowledged TELUS’ higher than initially contemplated leverage at YE2022, after the expected Q4 2022 close of the LifeWorks transaction, but reflected the outlook for continued solid telecommunication operating results, rapid growth in non-telecommunication business exposure, and acknowledged that prior to the announcement of the LifeWorks acquisition, the Company was deleveraging ahead of DBRS Morningstar’s most recent expectations.

Since that time, TELUS reported 2022 results as of the third quarter ended September 30, 2022 (Q3 2022). Year to date (YTD) revenue and EBITDA of $13.4 billion (+7.8% year-over-year (YOY)) and $4.8 billion (+9.1% YOY), respectively, that support full-year 2022 results at or better than DBRS Morningstar’s forecast. EBITDA growth was solid across both TELUS International (+35.7% YOY) and TELUS Technology Solutions (+6.5% YOY), which was driven primarily by net subscriber additions in both mobile and fixed product services, a mobile average revenue per user of 1.7% YOY, and an industry-leading blended wireless churn of 0.86%. In terms of the YTD Q3 2022 financial profile, DBRS Morningstar cash from operations was $4.9 billion, up 12.5% YOY. While DBRS Morningstar free cash flow (after dividends, but before changes in working capital) was $153 million compared with $452 million in the prior period, the change is attributable to higher capital expenditures of $2.9 billion compared with $2.2 billion as the Company continues to execute on its two-year accelerated broadband and 5G investment program that concludes at YE 2022. Notwithstanding the Company’s issuance of equity to support both acquisition activity and also extraordinary events (over $4.0 billion of net equity issued since 2020), TELUS’ gross debt increased to $25.5 billion as of Q3 2022 including the LifeWorks acquisition, up from $18.6 billion at YE2019. As a result, reported last twelve months [ending/ended] XX, 2022, leverage was 3.77 times (x) compared with 3.33x at YE2021.

TELUS is expected to continue to deliver mid-single digit telecommunications revenue and EBITDA growth as the Company leverages its network and 5G investments for both consumer and enterprise customers. DBRS Morningstar believes for the foreseeable future TELUS is likely to continue to maintain its focus on strategic acquisitions in order to develop its market presence and capabilities within the non-telecommunications businesses (i.e., TELUS International, TELUS Health, and TELUS Agriculture & Consumer Goods). DBRS Morningstar expects this to result in high-single digit to low-double digit reported revenue and EBITDA growth over DBRS Morningstar’s forecast horizon.

TELUS has a track record of delivering industry-leading EBITDA growth, integrating acquisitions efficiently (and ahead of plan in the case of LifeWorks), leveraging its network in order to gain market share, and being able to establish a unique position in the Canadian telecommunications landscape. Leverage is expected to remain comfortably placed in the BBB category, providing a cushion for continued acquisitions-driven growth and spectrum investments in 3800 MHz and mmWave in 2023 and 2024 (with payments expected to be due in 2024 and 2025); high-single digit increase in dividends; and network investment. DBRS Morningstar notes liquidity events such as assets sales, partnerships, selling ownership stakes, and real estate divestitures may contribute to the Company being able to deleverage in a manner that is more aggressive than DBRS Morningstar’s outlook; however, this is not required to maintain the BBB rating category.

DBRS Morningstar believes in the BBB rating category TELUS has considerable financial flexibility to continue to pursue opportunistic acquisitions that enhance the service offering and customer/geographic diversification of its non-telecommunications businesses. It also provides an additional cushion to fund the upcoming 3800 MHz and mmWave spectrum license auctions that are expected to affect cash flows in 2024 and 2025, while continuing to invest in the network and return capital to shareholders through continued dividend growth, but does not necessarily demand a reduction in debt levels in order to maintain the current rating category.

The new ratings are supported by TELUS’ well-entrenched market position and proven track record of profitable growth across its asset base, while also reflecting intensifying competition, risks associated with regulatory and technological change, as well as the industry’s capital-intensive nature.

Looking ahead, a positive rating action may occur if TELUS is able to achieve its target of high-single digit to low-double digit EBITDA growth over the next few years. This will occur only if the Company is able to deleverage as a result of EBITDA growth and/or liquidity events in which the proceeds are directed to debt reduction such that leverage declines to approximately 3.0x, while balancing capital allocation between growth, investment, spectrum, and shareholder returns, and shows the willingness, ability, and execution to achieve its long term leverage target of 2.50x to 2.75x.

Conversely, if TELUS were to experience a soft operating performance that falls materially below current expectations and pursue more aggressive financial management such as aggressive shareholder returns, accelerated debt-financed acquisition activity, or a combination of these factors in which leverage appears to be structurally more than the 3.50x to 3.75x range, a negative rating action may occur.

ENVIRONMENTAL, SOCIAL, AND GOVERNANCE (ESG) CONSIDERATIONS
There were no Environmental/Social/Governance factor(s) that had a significant or relevant effect on the credit analysis.

A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework can be found in the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings at https://www.dbrsmorningstar.com/research/396929 (May 17, 2022).

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

The principal methodologies are Rating Companies in the Communications Industry (July 21, 2022; https://www.dbrsmorningstar.com/research/400203), DBRS Morningstar Criteria: Guarantees and Other Forms of Support (April 4, 2022; https://www.dbrsmorningstar.com/research/394683), and DBRS Morningstar Criteria: Commercial Paper Liquidity Support for Nonbank Issuers (March 1, 2022; https://www.dbrsmorningstar.com/research/393065), which can be found on dbrsmorningstar.com under Methodologies & Criteria.

A description of how DBRS Morningstar analyzes corporate finance transactions and how the methodologies are collectively applied can be found at: https://www.dbrsmorningstar.com/research/397223/interplay-of-global-corporate-finance-rating-methodologies-when-analyzing-corporate-finance-transactions.

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 under Related Documents or by contacting us at [email protected].

The rated entity or its related entities did participate in the rating process for this rating action. DBRS Morningstar had access to the accounts and other relevant internal documents of the rated entity or its related entities in connection with this rating action.

The conditions that lead to the assignment of a Negative or Positive trend are generally resolved within a 12-month period. DBRS Morningstar trends and ratings are under regular surveillance.

For more information on this credit or on this industry, visit www.dbrsmorningstar.com or contact us at [email protected].

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