RE: TD maintains buy.Details from TD's buy recommendation today:
TELUS Corp.
(T.NV-T) C$43.70
2005 Targets Achieved, and 2006 Guidance Remains Intact
Event
TELUS reported Q4/05 results.
Impact
Neutral. We maintain our Action List BUY rating on TELUS (T.NV) shares,
with our 12-month target price intact at $60.00. When adjusted for unusual
items, the company delivered Q4 results that met or exceeded our
expectations. Furthermore, 2005 results were in line with the most recent
management guidance in every single category. Perhaps even more
impressive is that full year 2005 results met or exceeded all of the
consolidated financial targets (revenue, EBITDA, EPS, capex and FCF) that
were originally set back in December, 2004, despite the introduction of VoIP
competition, and despite the incurrence of $133 million in strike costs that
were not contemplated in the original guidance. Given this impressive track
record, we have a lot of faith that the company can meet or exceed its
guidance for 2006, and we note that management reaffirmed all of the
guidance metrics that it originally established on December 16, 2005. Our
forecasts for 2006/2007 remain largely intact, and we continue to believe that
T.NV shares deserve a premium valuation owing to its industry-leading
growth profile and revenue mix.
1) Wireless Subscriber Loading Hurt EBITDA in Q4
TELUS had a record quarter of subscriber additions, with 235K versus our
forecast of 210K, which was well up from 186K last year. With Bell adding
210K subs and Rogers adding 217K subs in Q4, TELUS was the market share
leader with 36%. We view this as a favourable dynamic that should boost
growth in future periods, but the heavy subscriber loading clearly had a
negative impact on EBITDA growth and margins in the period. Reported
wireless EBITDA growth was only 14% y/y, which was still at the high end
of the guidance range, but it was the lowest we have seen since the Clearnet
acquisition. Reported margins on service revenue declined to 39.8% from
40.9%. However, adjusted EBITDA growth would have been 25%
instead of 14%, and adjusted Q4 margins would have increased to 43.6%
instead of dropping to 39.8%.
2) Increase in Prepaid Mix Appears Temporary
Despite the strong overall sub adds in Q4, we were a bit concerned that prepaid accounted for 39% of the total,
which was above our forecast of 24%. Management indicated that the company intends to remain focused
primarily on postpaid adds going forward, and that the prepaid spike in Q4 related to the success of a holiday
promotion, which no longer exists. Despite the negative mix in Q4, we note that TELUS still has the best
overall postpaid/prepaid mix in Canada, at 81%/19%, versus 78%/22% at Rogers, and 74%/26% at Bell.
3) Canadian Wireless Market Growth Accelerated in 2005 - Risk of a New Entrant is Minimal
TELUS highlighted that the 5.1% penetration gain for the Canadian wireless industry in 2005 (46.7% to
51.8%) was the best performance since 2001. Management estimates that penetration growth will remain
stable at about 5% in 2006, so we do not believe investors should be overly concerned about a material
deceleration in subscriber growth in the near term.
4) Cost Reduction Flexibility has Improved with the New Union Contract
We expect the legacy local and LD revenue streams at TELUS to come under increasing pressure in the future,
as Shaw and other VoIP providers expand in the market. Consequently, in order to preserve profit margins in
the future, we are pleased to see that the company has started to take advantage of the increased flexibility of
its new five year union contract. Management indicated that 507 high cost jobs in non-core areas have been
outsourced to date (about 40% of these employees have been reassigned to other areas of the company), and it
expects to eliminate another 200 positions upon the consolidation of two call centres and a dispatch centre. In
addition, management highlighted that the reduction of nine vacation days for about 6K employees would
result in an extra 54K working days per year. We estimate that this equates to about 216 new full time
employees at no extra cost. We expect further cost reduction initiatives going forward, but unlike some of its
peers, we do not believe that TELUS wants to pre-announce restructuring moves and headcount reduction with
a lot of fanfare.
Valuation
TELUS currently trades at 5.9x 2006e EBITDA and 10.5x 2006e FCF, which are at a discount to other North
American telcos.
Justification of Target Price
We are now looking forward to 2007 forecasts to generate our target price. Our primary valuation
methodology is based on segmented multiples of 9.0x 2007e EBITDA for wireless, and 5.0x 2007e EBITDA
for wireline, which generates a mid-2007 target price of $64.00. We then discount this figure by 6% (implies a
half year discount at an annual rate of 12%) to derive an end of 2006 target price of $60. The $60 target price
equates to 7.6x 2006e consolidated EBITDA and 23.3x 2006e EPS, which are premiums to other North
American telcos owing to our view of the superior asset mix and growth profile at TELUS.
Key Risks to Target Price
The following factors could negatively influence the T.NV share price: 1) Increased competition among the
three wireless carriers in Canada; 2) Adverse regulatory rulings, such as new 3G spectrum licenses, could
increase competition among the existing wireless operators or encourage new entrants to the market; 3)
Irrational capex spend on wireless infrastructure or TELUS’ IP network could compromise the company’s
strong FCF; and 4) Higher than expected line losses to Shaw’s VoIP service.
Investment Conclusion
As street valuations roll forward to 2007, we believe T.NV shares will stand out as being undervalued at 5.4x
EBITDA (if we back out wireless at 8 or 9 times EBITDA, then the wireline assets are trading at an
unreasonably low multiple of 2.6 or 1.6 times 2007e EBITDA). We also note that the company is expected to
become active once again on its 24 million share buyback program now that Q4 results have been released.