Telus and its fellow Canadian telecom giants have been a source of frustration for many, including myself as a customer. The poor service and billing issues have been a common pain point, and it's no surprise that these companies have underperformed in the market over the past couple of years. One of the key concerns for investors is the sustainability of their dividends, and Telus' dividend yield of 11.2% is certainly raising eyebrows.
When a dividend yield hits double digits, it's a red flag. It could indicate a sharp drop in share price or a company paying out more than it can comfortably afford. In Telus' case, it's a bit of both. The dividend payout ratio, when calculated using earnings, is a staggering 278%, which is misleading due to the nature of the telecom industry's accounting practices. Companies like Telus have significant depreciation expenses, which are non-cash charges, and they also face restructuring costs and heavy infrastructure investments.
Free cash flow is a better indicator of dividend sustainability, and even then, Telus is paying out 110% of its unadjusted free cash flow. Adjusting for their dividend reinvestment plan (DRIP), which is being phased out, the ratio improves to around 75%. While this is an improvement, it's still at the higher end of Telus' long-term target range of 60-75%. Management is aware of this and has taken steps to address it, including pausing dividend growth and focusing on improving the balance sheet.
Should investors buy Telus stock? Personally, I'd advise against it. The situation reminds me of BCE's dividend struggles, where a similar pattern emerged: dividend growth stalled, the yield climbed, and investor confidence eroded. Eventually, BCE cut its dividend by 50%, and the share price adjusted accordingly. While Telus may not follow the same path exactly, the signs are worrying. Telus built its investment case on a reliable, growing dividend, which attracted income-focused investors. When dividend growth stops, investors start to worry about potential cuts, leading to a loss of confidence and a potential sell-off, creating a negative cycle.
There might be value in Telus in the future, but for now, the risk-reward ratio isn't appealing. For income-seeking investors, Canada's banks and pipeline companies offer more stable and attractive fundamentals in both the short and long term.
