Investment thesis

TELUS Company (NYSE: YOU) is a Canadian telecommunications company that offers a variety of services that include, Internet, television, hosting, managed information technology and cloud-based services, and healthcare solutions. The company operates in a mature, recession-proof, slow-growing industry and offers a strong yield that is attractive to income-seeking investors. That being said, TELUS has a variety of issues, including a depleted financial position, political risk and questionable dividend security. For this reason, although TELUS is touted as a relatively robust business model, investors should look elsewhere for a high yielding stock.

Questionable Dividend Safety When Reviewing Payout Ratios

For starters, TELUS has questionable dividend security given its leverage and high payout ratio. Over the past 5 years, the company’s dividend payout ratio has increased parabolically.

The primary driver of TELUS’ payout ratio increase is the company’s stagnant EPS growth, which has resulted in TELUS’ dividend per share growing faster than this. Since 2012, TELUS’ dividend per share has grown at a CAGR of approximately 6%. Meanwhile, the company’s EPS over that same time horizon has only grown at a rate of 0.5%.

Additionally, the company’s cash dividend payout ratio remains relatively high at around 80%, so even adjusting the payout ratio on a cash flow basis, we are still with a relatively high figure. Since most retail investors investing in TELUS shares are looking for growth and strong dividends, it seems they may need to consider looking elsewhere. If EPS growth remains stagnant, we could potentially see much weaker dividend growth or even worse a drop in dividends.

Exhaustion of the financial situation

Another reason why TELUS might not be a dividend-paying stock to add to your portfolio is the company’s growing leverage. Since 2009, the company’s total debt has grown at a CAGR of 10%. As a result, the interest earned by the company followed a downward trend.

Additionally, the company’s total debt to equity ratio has been mostly on an upward trend over the past 10 years. This further indicates a depleting balance sheet.

As an investor looking for dividends, I would be wary of these historical leverage and coverage metrics as the company’s growing leverage could become troublesome, especially as we appear to be entering an environment of rising interest rates. Issues with managing increased leverage and higher borrowing costs could lead to critical divestments of large projects, allowing other competitors to catch up on critical technology development. Additionally, the higher debt burden could also reduce future dividend growth.

Political risk: the federal government potentially opens the doors to foreign competition

Although Canadians currently have little bargaining power with the country’s three major telecommunications providers, this does not mean that they are necessarily satisfied with the services they receive. According to a survey conducted in 2021, 1 in 3 Canadians say they are dissatisfied with their mobile networks.

In addition, Canadians must pay some of the highest fees in the world for basic telecommunications services such as mobile data plans. This issue has been discussed in Ottawa among politicians to the point where in the last election the Progressive Conservative Party of Canada said that if elected it would promise to allow foreign telecoms into the Canadian market in order to encourage increased competition.

Today, although the PC party lost to the Liberal Party in 2021, politicians in Ottawa are still under massive political pressure to reduce the cost of specific mobile services. A bipartisan agreement to allow foreign telecoms to enter the Canadian market may still be on the table. If that were to happen, not only could TELUS’ margins be squeezed, but aggressive investments by major US suppliers could potentially threaten the company’s strong presence in their home market. Also, even if politicians do not allow foreign companies to enter the Canadian telecommunications market, I still have to assume that some kind of policy to reduce the cost of mobile data plans will emerge.

That being said, we have no idea how Canadian politicians will decide to legislate to reduce the cost of mobile data plans. We also don’t know the financial ramifications of their decisions, creating an incalculable risk factor.

Valuation: overvalued compared to its domestic and global peers

Using comparable cost analysis, I was able to compare TELUS’ price and enterprise value ratios to those of its closest national and global peers.

As you can see by looking at all of the key valuation ratios, TELUS is overvalued when looking at both average and peer average. Combine that with the fact that their dividend security, as we have seen, is below average and they face some political risk. My general consensus is that TELUS shares are overvalued given the trading multiples, risks and financial condition of the company.

Conclusion: There are better alternatives

To wrap up my bearish thesis, I think income investors should overlook the allure of TELUS’ competitive landscape due to the company’s lack of dividend security, rising leverage and potential political risks. I think investors looking for high yield in Canada would do better in the short to medium term by buying Suncor Energy (NYSE:SU) and Enbridge (NYSE:ENB). Investors with a long-term investment horizon are better off buying Canadian financials when they see a pullback. Overall, TELUS has a robust business model, but there are better high-return names for your income portfolio.