Dividend Stock Analysis of TELUS

Michael is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Canadian telecom stocks have been dropping in price ever since Verizon Communications (NYSE: VZ) announced that it plans to buy WIND Mobile. Rogers Communications (NYSE: RCI) and TELUS (NYSE: TU) have been hit the hardest because a large portion of their income is from wireless communications, which Verizon Communications would compete for. With the recent drop in prices, Rogers Communications is getting close to my target price. So, I thought it would be a good time to review TELUS. 

Dividends

A quick look at the Canadian Dividend All-Star List tells me that TELUS has increased its dividend for nine consecutive years in a row. The most recent increase happened with the dividend recorded last month (June 2013) when it increased the quarterly dividend 6.3% from $0.32 to $0.34. There was a recent 2:1 stock split so the previous dividend of $0.32 was actually $0.64, but I adjusted it to $0.32 for the 2:1 stock split. The dividend table below has not been adjusted for the 2:1 stock split in 2013.

Dividend growth

As you can see from the table below, TELUS shows good average annual dividend growth rates.

Estimated future dividend growth

Analysts expect annual EPS growth to be 8% for the next five years. Accepting this EPS growth rate and using a payout ratio range of 65% to 75% would result in annual dividend growth ranging from 8% to 11.1%. The company recently announced that it plans to increase its dividend twice a year for three years with an average annual growth rate around 10%. This is in-line with my range of 8% to 11.1%, so my guess is that it will be around 10%.

One thing to point out is that the analysts' estimate of 8% annual EPS growth rate for the next five years likely hasn’t been adjusted for the Verizon entry. This rate might drop a bit in the future once analysts make adjustments for Verizon. In the short-term, I don’t think it will affect EPS much if at all, but in the long-term, Verizon may have a negative impact.

Competitive advantage & return on equity (ROE)

TELUS has a decent return on equity. I’d like to see it stabilize and trend upward.

TELUS has a ROE that is well above the Wireless Communications industry average of 11.9%, but when compared to its Canadian competitors, it falls a little short. I threw in Verizon Communications out of curiosity, but right now, I wouldn’t consider it a major competitor in Canada.

I would consider TELUS to have a narrow economic moat. There are only a few key players in the industry, but the industry is highly competitive. While it may be difficult to enter the industry, the current competition is strong enough to take away a significant competitive advantage.

Valuation

Morningstar currently rates TELUS a 4-star stock as it is currently priced under their estimated fair value of $38. For Morningstar to rate TELUS as a 5-star undervalued stock, the price would have to fall below their “consider buy price” of $26.60.

I calculated my own target prices and came up with $22. To see the details of this calculation, read the full analysis of TELUS.

Other investment options in the same industry

TELUS shares the industry with Rogers Communications, Shaw Communications (NYSE: SJR), and BCE (NYSE: BCE). Because of the recent news that Verizon Communications may be entering the industry, I included it in the chart as well.

* Information in the tables above and below for TELUS, Rogers Communications, Shaw Communications and BCE is from the Toronto Stock Exchange, not NYSE.

Rogers Communications has the lowest payout ratio and a decent estimated EPS growth rate of 6.3%, which should translate into good dividend growth. Its past dividend growth rates have been good with all of them being above 10%, including the most recent increase. No dividends were paid in 2002, so the 10-year dividend growth rate couldn’t be calculated. The nine-year average annual dividend growth rate is an impressive 46.8% though. With potential for new competition from Verizon, I’m comforted by their low payout ratio compared to the others.

BCE offers the highest yield, but has low dividend growth prospects. BCE’s payout ratio is fairly high at 67.93%. This does not allow for much dividend growth beyond its EPS growth rate. Currently, analysts expect EPS to grow 4.5% annually for the next five years, which suggests limited future dividend growth. My guess is that it will be around 4% or 5% annually. BCE has the lowest dividend streak, and the limited dividend growth potential will keep me on the sidelines for now. BCE doesn’t have as much of its income coming from wireless sources, so the Verizon entry wouldn’t affect it as much as Rogers Communications or TELUS.

Shaw Communications has a good dividend streak, a reasonable payout ratio, and a decent estimated EPS growth rate of 6%, but the recent dividend increases have been around 5%. This is 3% lower than the 8% I like to target. The company recently stated that they plan to target dividend increases of 5% to 10% over the next two years due to an improvement in free cash flow. It is hard to say if dividend growth will meet my 8% target, which is why I prefer TELUS and Rogers Communications. Shaw Communications doesn’t have any of its income coming from wireless sources, so the Verizon entry shouldn’t affect it.

Verizon Communications has a good dividend streak of eight years, but its dividend growth is not very impressive as it has generally been around 3% or 4%. Its payout ratio is really high when compared to the EPS from the last twelve months. I looked into this a bit further and analysts expect EPS for 2013 to be $2.80, which would result in a more reasonable, but still high payout ratio of 73.57%. The annual estimated EPS growth rate of 10.5% is good, but because of its high payout ratio, I think dividend growth will be lower than EPS growth. I don’t plan on investing in Verizon Communications.

From a valuation perspective, Rogers Communications looks to be the best option right now.

Rogers Communications is the only company that is currently rated a 5 star stock by Morningstar. Its current yield is the highest above its five year average, coming in 27% higher. It is currently a little above my $38 target price, but it is still the closest to my target compared to my other target prices of $22 for TELUS and $20 for Shaw Communications. Right now, Rogers Communications looks more appealing than TELUS.

Conclusion

TELUS has seen its price drops recently due to the announcement from Verizon, but it still needs to come down a lot more for it to reach my target price of $22. I expect dividend growth around 10% going forward. While 10% annual dividend growth is appealing, I think you can get similar rates from Rogers Communications with a better overall valuation. Overall, TELUS is a well run company and I’d be happy to invest more, but its valuation is currently too rich for me. 

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Michael Weber owns shares of TELUS and BCE. The Motley Fool recommends Rogers Communications (USA). Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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