EUR 850.00 For Business Accounts Only

Morningstar | Telus Ends 2018 With Another Solid Quarter and Results That Justify Its Fiber Build

Like its wireless peers, narrow-moat Telus reported excellent subscriber numbers in the fourth quarter. All major Canadian providers, as well as upstart Freedom Mobile, have produced numerous strong quarters in a row, which we broadly attribute to the Canadian consumer more than any individual company's strategy. In our view, the greater point of differentiation for Telus is in its wireline business, where it had its best fourth quarter in five years and is reaching the tail end of its fiber-to-the-premises build-out. We expect Telus' wireline business to continue outperforming, but we think that the wireless business will remain highly competitive and industry tailwinds will moderate in 2019. We don't expect to make material changes to our CAD 49 fair value estimate, leaving the stock only mildly undervalued at current levels.

Adjusted EBITDA, up 4%, could not keep up with Telus' 6% year-over-year revenue growth in the fourth quarter, but it does not materially affect our long-term forecast, which calls for negligible margin expansion over the next five years.

We've been big fans of Telus' strategy to build fiber over most of its footprint. Although up-front costs are significant, we believe fiber results in better cost efficiency than the firm's legacy copper networks and, crucially, an offering more competitive with its cable peers. Telus is now seeing the payoff with subscribers, and we can see the end of the steeper capital spending on the horizon. Telus added 28,000 high-speed Internet customers in the quarter and 115,000 for the full year, the first time it eclipsed 100,000 in at least a decade. More impressively, in a time when television subscriptions are waning, Telus added 24,000 in the quarter and 63,000 for the year. Along with growth in Telus Health and Telus International, subscriber growth contributed to wireline revenue being up over 7% in the quarter and 8% for the year, despite continued contraction in voice customers.

On the wireless side, Telus added 112,000 postpaid subscribers in the quarter, the same as Rogers and within 10,000 of BCE. We believe Canadian wireless penetration, which at less than 90% sits well below the 100%-plus of many developed nations, is driving net additions for everyone, but we think it's very competitive and now decelerating. Telus added 356,000 postpaid subscribers in 2018, which remains high in absolute terms but is a drop from 2017's 379,000. Average billing per user declined 70 basis points versus last year's fourth quarter and was up less than half a percentage point for the full year. Adjusted EBITDA margin contracted slightly as well in both the quarter and year. We expect wireless penetration in Canada to increase, which will continue driving decent subscriber additions over time, although we think we've seen the near-term peak. However, we expect ABPU growth to be meager (averaging just over 1% annually for Telus in our model) and, with a lack of pricing power, to weigh on margins. We project slight wireless margin contraction over our forecast.

On its earnings call, management addressed the Huawei controversy, but it did not provide details or quantify what various scenarios would mean. We think some investors were alarmed when, in its annual report, Telus noted that a government decision to ban Huawei equipment "could have a material…increase in the cost of Telus' 5G deployment." We view that statement as legalese that is standard when companies discuss risk factors. While costs would certainly be substantial if Telus was forced to replace all existing Huawei equipment that it has deployed in its 3G and 4G networks, we think the cost would be less noticeable if a ban were solely for 5G equipment. Additionally, Telus noted that it does not deploy Huawei equipment in the core of its 3G and 4G networks, but rather only at the edge for less security-sensitive antennas and radios. It said that if it were to otherwise choose Huawei as its 5G provider (which it has not done yet), it would similarly keep that equipment limited to the edge. Management indicated that countries banning Huawei equipment in Europe have limited the ban to core equipment. We think the most likely scenario is that Telus is not greatly affected by whatever decision the Canadian government reaches, but a worst-case scenario, covering all previously deployed 3G and 4G equipment, would have a major impact.