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Telus Stock: Undervalued, but is Its Debt Sustainable?
Stock Analysis & Ideas

Telus Stock: Undervalued, but is Its Debt Sustainable?

Story Highlights

Telus has been improving its efficiency over the past few years and also appears to be undervalued. However, investors should be aware of its heavy debt load, which may hinder the company in a rising-rate environment.

Telus Corporation (TSE: T) (TU) provides a broad range of telecommunications products and services in Canada. It offers wireless, wireline, Internet, and communications services for voice and data to consumers and businesses. It also provides entertainment, healthcare, video, and IPTV television services in the country.

Telus has been improving its efficiency over the past few years and also appears to be undervalued. However, investors should be wary of its heavy debt load.

Measuring Efficiency

Telus needs to hold onto a lot of inventory in order to keep the business running. Therefore, the speed at which a company can move inventory and convert it into cash is very important in predicting its success. To measure its efficiency, I will use the cash conversion cycle, which shows how many days it takes to convert inventory into cash. It is calculated as follows:

CCC = Days Inventory Outstanding + Days Sales Outstanding – Days Payables Outstanding

Telus’s cash conversion cycle is 38 days, meaning it takes the company 38 days for it to convert its inventory into cash. In the past several years, this number has trended downwards, indicating that the company’s efficiency has improved.

In addition to the cash conversion cycle, let’s also take a look at Telus’s gross margin trend. Ideally, it’s good to see a company’s profit margins expand each year. This is, of course, unless margins are already very high, in which case it is acceptable for them to remain flat.

In Telus’s case, its gross margin has remained relatively flat in the past several years, going from 35% in Fiscal 2012 to 35.8% in Fiscal 2021. This demonstrates that competition hasn’t forced the company to lower the price of its goods.

Valuation

To value Telus, I will use the H-Model, which is similar to a three-stage DCF model. The H-Model assumes that growth will decelerate linearly over a specified period of time. I believe this is a reasonable assumption, as companies gradually slow down as they mature.

The formula is as follows:

Stock Value = (CF(1+tg))/(r-tg) + (CFH(hg-tg))/(r-tg)

Where:
CF = dividend per share
tg = terminal growth rate
hg = high growth rate
r = discount rate
H = half-life of the forecast period

For Telus, we used the following assumptions:
CF = C$1.3544 per share
tg = 3.3% (used 30-year Government of Canada yield)
hg = 7.3% (used seven-year dividend CAGR)
r = 8.3%
H = five years (we are assuming it will take 10 years to reach terminal growth)

As a result, I estimate that the fair value of Telus is approximately C$33.4 under current market conditions. At a current price of around C$30, this leaves the stock in potentially undervalued territory.

However, it is worth noting that the company’s dividend payout actually exceeds its free cash flows. As a result, the company has been taking on a lot of debt over the past several years and now has a total debt/free cash flow ratio of 17.6x. With interest rates rising rapidly, the dividend could be negatively impacted, going forward.

Analyst Recommendations

Telus has a Moderate Buy consensus rating based on three Buys and four Holds assigned in the past three months. The average Telus price target of C$34.95 implies 16.6% upside potential.

Final Thoughts

Telus appears to be undervalued, as both analysts and the H-model produce very similar price targets with a narrow range. However, the company’s heavy debt load may cause the company issues if interest rates rise too much.

Disclosure

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