CFA Institute Research Challenge hosted by CFA Society Vancouver Team C Integrated Telecommunications Service sector Team C Toronto Stock Exchange This report is published for educational purposes only by students competing in the CFA Institute Research. Challenge. th Date: January 20 , 2017 Closing Price: $43.84 Recommendation: HOLD Ticker: T CN CAD 1.00 = USD 0.75 Target Price: $44.63 Market Profile Closing Price $43.84 Highlights 52-Week High/Low $44.40/$37.38 We initiate coverage on TELUS with a HOLD recommendation and target price of Avg. Volume (3M) 994,011 $44.63 one year going forward. This implies a 1.79% upside based on the company’s Shares Outstanding 591.40 million closing price as of January 20th, 2017. Given our expected dividend payment of $1.98 Market Cap $25.99 billion per share in 2017, we derive a total return of 6.31%, which is less than TELUS’s costs of equity and, thus, justifies our HOLD recommendation. Beta 0.90 EV/EBITDA 8.59x Business Model – TELUS generates most of its revenue through its telecommunication infrastructure which requires ongoing capital expenditures to P/E 18.61x maintain revenue growth. Dividend Yield 4.37% Competitive Positioning – TELUS is characterized through the highest ARPU as Key Financial Data well as the lowest churn rates among its peers. However, ongoing competition 2013 2014 2015 could drive down ARPU and lower revenue growth. Rev. Growth 4.4% 5.2% 4.2% Industry Trends – Rapid technological advancements and structural changes EBITDA Ma. 35.2% 35.1% 34.1% intensify pressure on telecommunication companies. High penetration rates and Profit Ma. 11.3% 11.9% 11.1% slowing revenue growth indicate a mature stage of the industry. EPS 2.08 2.31 2.29 Financial Analysis – Solid financial performance through stable EBITDA Div./share 1.36 1.52 1.68 margins and revenue growth. High infrastructure investments decrease cash-flow generation and increase debt levels. Div. Yield 3.7% 3.6% 4.4% ROE 16.5% 18.4% 18.3% Valuation – TELUS’s shares provide limited upside potential for capital Valuation Summary appreciation. High dividend growth rates are expected to slow down and cash flow to equity is anticipated to decrease through higher capital expenditures. Method Price Weighting Consequently, we expect yearly total return for investors to decrease until the FCFF $43.06 25% price has adjusted to its fair value. FCFE $34.29 20% Risk – Regulatory uncertainty and increasing competition influence the outlook DDM $41.52 25% on TELUS’ share price. Higher churn rates and decreasing ARPU are considered major risk factors and could alter our investment decision. EV/EBITDA $45.88 10% P/E $50.63 10% Recent News P/Book $52.07 10% January 18th, 2017 – TELUS announced presentation of fourth quarter results to $42.94 100% be webcasted on Thursday, February 9th, 2017. Cost of equity – th 3.93% January 17 , 2017 – TELUS invests $250 million in its fibre optic network. Div. Yield TELUS plans to connect more than 90% of homes and businesses in Surrey, B.C. 12 month target $44.63 directly to its fibre optic network. Surrey is the second largest municipality in the Expect. Div. 2017 $1.98 province and provides further growth potential for new customers. Total return 6.31% Last-Twelve-Month Performance Monte Carlo Simulation - 1 year forward 125% 120% 9.8% 73.3% 16.9% 14 9.8% 73.3% 115% 12 110% 10 Thousands 8 105% 6 100% 4 2 95% 0 90% 01/2016 04/2016 07/2016 09/2016 12/2016 T CN SPTSX 1 Business Description Figure 1. TELUS Structure TELUS Corporation is a Canadian telecommunication company headquartered in Vancouver, TELUS British Columbia. It is the incumbent communication service provider in British Columbia and Corporation Alberta with a strong market share in both of its primary segments, Wireless and Wireline (Figure 1). TELUS mostly generates revenue through its telecom infrastructure. It provides a wide range of related products and services such as data, internet, voice and television as well Wireless Wireline as cloud based to businesses and households. (See AppendixA1 for detailed corporate structure) Wireless Data Voice The wireless segment, which makes up 55% of overall revenue (Figure 2), is TELUS’ fastest growing business unit, generating most of its revenue through voice and data services. In 2008, Advanced Internet Solutions IPTV TELUS and Bell Canada agreed on a network sharing contract to compete directly with Rogers Communication. TELUS is operating under two brands, TELUS Mobility and Koodo both of which focus on separate market segments. While Koodo is offering lower priced products, Small TELUS mobility addresses higher-end segments. Healthcare Business Solutions Wireline According to Figure 2, the Wireline segment makes up 45% of TELUS’ revenue, providing voice and data services such as IPTV, internet, hosting services, local and long distance landline Figure 2. Total Revenue share connections. According to Figure 3 data services account for 69% of wireline revenue. Apart from this, TELUS also offers several products for small and medium businesses such as cloud based PBX, network and cloud solutions which aim to provide affordable process optimizations. Driven by continuous product diversification, TELUS recently launched its healthcare segment and became the largest EMR provider in Canada by offering various 45% healthcare solutions such as claim management and health monitoring. 55% One of the most recent trends is TELUS’s IPTV and Satellite TV service known as Optik TV which allows subscribers to access more than 630 digital channels. Future expansions TELUS continues to invest in wireless capacity and network growth as well as in broadband infrastructure expansion and upgrades. One of its strategic objectives is to increasingly connect Wireless Wireline businesses and residential units with fibre-optic cable, by expanding rural broadband Source: TELUS Annual Reports. connections. These investments increase internet speeds and the capacity to support TV, Internet and data service growth. It also enhances the reach of its healthcare solutions, and Figure 3. Wireline Revenue share provides backhaul capability to expand wireless services. TELUS mainly focuses on the telecom business; however, successfully adapts to industry changes and is resilient enough to 4% overcome economic downturns. Management and Governance 27% The average tenure of TELUS executives has exceeded the respective tenure of peer companies by around 25% which indicates higher loyalty and lower turnover. (Appendix B1a) Fourteen years as the company’s CEO, Darren Entwistle guided TELUS through a period of rapid 69% growth. He returned to his old position on August 2015 after a leave for fourteen months. Investors’ confidence grew after a 4.2% revenue growth the following month of Darren Entwistle’s reappointment and his $10 million investment in TELUS shares. The oversight of the board is realized through four committees Audit, Corporate Governance, HR & Compensation and Pension (Appendix B1b). Each committee is composed of board Data Voice Service Other directors with the objective to ensure the alignment of policies and strategy. In order to maintain Source: TELUS Annual Reports. a neutral standpoint in discussions and decisions, TELUS’ executive team is not involved in any of the sub-committees of the Board. Additionally, TELUS launched the National Sustainability Council in 2015 which is expected to solidify TELUS award-winning disclosure in corporate Figure 4. TELUS National Coverage governance. Embracing Culture Increasing diversity and inclusiveness have been reflected throughout all levels of the organization. A clear policy is supervised by the Corporate Governance Committee which enable TELUS to be recognized by Mediacorp Canada as one of the best employers with respect to diversity. Shareholders’ Rights To ensure shareholders’ rights, a Corporate Secretary has been designated by the Board as its agent to receive and review communications and meeting requests. A new policy has been adopted in 2015 to improve the previous say-on-pay and shareholder engagement policy in order to encourage timely, honest and ongoing dialogue. Code of Ethics Source: CRTC Data Collection The TELUS Code of Ethics and Conduct is used to assist TELUS team members in maintaining the highest standards of ethical conduct in the corporate and professional dealings. Ethicsline, as part of the annually renewed code allows team members to anonymously raise complaints. 2 ESG Figure 5. Revenues and Percentage Environmental, social and governance concerns could negatively influence the business going of Wireless Sector. forward which would alter our investment decision. Among its peers, TELUS has the most 50 52% percentage of independent director and meeting attendance percentage, indicating an organized management structure. In terms of ranking, TELUS scored the best in the RobecoSAM Rank, 40 51% 50% Sustainalytics Rank, ISS Quality Score and CDP Climate Score compared to peers Bell and 30 50% Rogers (See appendix B2). Our analysis of TELUS’s ESG factors show that there is a low 49% 48% 20 49% probability that ESG factors will have a negative impact on the valuation. 47% 46% 10 Industry Overview and Competitive Positioning 0 44% Industry Overview 2011 2012 2013 2014 2015 Over the past 5 years, the telecommunication industry saw an average annual revenue growth of wireline wireless 2.8% (Appendix C1a) with approximately 94% of revenue generated through services that are Wireless% no longer price-regulated. In general, the EBITDA margin for telecom companies is 39.8% with Source: CRTC data. a 7.6% growth 2014 to 2015 (Appendix C2a). The average ROE for the telecommunications sector is 15.5% and the average debt to equity ratio is 1.688 (Appendix C2b). The fastest growing segments are internet and wireless which capture around 70% of the Figure 6. GDP Growth of Canada. industry’s revenue. During 2011 to 2015, wireless data services alone grew by an average 3.50% annual rate of 18.8% and gained a market share to 51% (Figure 5).