While it seems positive that Telus hasn’t made any dividend cuts in recent years, the company also appears to be increasing its payout, with a payout ratio of 143.5%. That is well above the sustainable range. For this reason, I think investors should wait for a dividend cut before taking positions in Telus stock, as those who buy the stock today can hope against hope that the dividend will be maintained, both for the sake of the dividend itself and to avoid a major capital loss like the one BCE suffered after cutting its own dividend.
Canadian telos and dividends: a story a decade in the making
The past decade has been a difficult time for Canadian telecommunications companies, characterized by rising interest rates, intense competition and little to no pricing power. A few individual wins (such as Rogers’ (TSX:RCI.B) buyout of Shaw) Despite that, it has been a tough time for the industry. The question investors want to ask themselves is: why are telecom companies performing so poorly?
The answer has to do with dividends. Large dividend payments have been a problem for Canadian telecom companies over the past decade. The telco that historically had the highest payout ratio of the big three (BCE Inc) performed the worst of the bunch, delivering just a 9% total return. Rogers, which has the lowest payout ratio, has performed in second place, with a payout ratio of 48% and a price increase of about 5%. Telus, which has an average payout ratio, has performed the best, with a total return of 59% and a slightly negative price appreciation over the past ten years. Unfortunately, T has the highest ratio of the three today because it maintained its dividend when BCE cut.
It’s nice to see that Telus has achieved an “OK” total return despite a high payout ratio. However, the company appears to be pushing dividends today. As of the most recent announcement, T Stock paid $0.42 in quarterly dividends, on approximately $0.32 in quarterly earnings per share (EPS) and free cash flow (FCF) per share. The share has an attractive rolling dividend yield of 8.8%; However, BCE had a monster return even before the recent dividend cut. While it would be nice to think that Telus will continue to pay this high-yield dividend in the future, the company’s dividends are so far ahead of earnings that the situation seems unsustainable. Based on BCE’s experience, we would have to imagine that a dividend cut by Telus would be followed by a negative capital gain, due to investors’ (irrational, excessive) dividend preference.
My final verdict: wait for a discount and then buy
Over the past decade, Telus has been the best performing Canadian telecom company, with a total return of 59%. However, it’s starting to look like some of that run has been unsustainable. Dividend stocks that cut their dividends tend to suffer large capital losses as investors digest the effects of lower dividends in the future. However, when companies have unsustainable payout ratios, such cuts are exactly the medicine they need. So Telus may have to hurt its current investors in the short term in order to make a profit in the longer term.
For this reason, I think potential Telus investors should wait for a dividend cut before buying the stock. Should such a downgrade occur, the share price would likely fall sharply, providing an attractive entry price and more sustainable dividends in the future. In the meantime, those looking to play Canadian telcos might want to consider Rogers, which has a sustainable 40% payout ratio and much better 10-year earnings per share than Telus, whose 10-year total returns appear to have been buoyed by unsustainable dividends.
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