Fitch Ratings has downgraded TELUS Corp.'s and TELUS Communications, Inc.'s Long-Term Issuer Default Rating (IDR) to 'BBB' from 'BBB+'.
The Rating Watch Negative has been removed and the Rating Outlook is Stable. Fitch placed TELUS on Rating Watch Negative due to the effect on TELUS's credit profile from the acquisition of LifeWorks, which closed in September 2022.
TELUS has continued to be acquisitive; in October, TELUS International (Cda) Inc. (TI) announced an agreement to acquire WLTR Holdings, LLC (WillowTree), a digital product provider, to augment TI's design and build capabilities. While both transactions were partly funded by equity, each was leveraging overall at a time when the company's EBITDA leverage metric had been above Fitch's negative rating sensitivity for several years due to previous spectrum and fiber investments.
Key Rating Drivers
Strong Market Position: TELUS's ratings reflect its operations as one of the three principal national mobile operators in the Canadian market, as well as its leading market position as a local wireline operator offering high-speed data, IPTV and voice services in western Canada and eastern Quebec. The company's Digitally-Led Customer Experiences-TELUS International (TI) segment is gaining scale and contributing to growth.
Strong Operational Performance: Revenues are expected to grow approximately 8% in 2022, after increasing 9% in 2021. Fitch assumes recent acquisitions combined with solid operational performance may boost revenue growth into the low double digits in 2023. Fitch also forecasts EBITDA growth in the mid-to high single digits in 2022 and the low double digits in 2023 due to strong growth at TELUS Health and TELUS International.
Elevated Leverage: Fitch expects gross leverage to be in the mid-3xrange in 2023 and trend down to the low 3x range in 2024 due to the LifeWorks and WillowTree acquisitions. Over 2020-2021, the company's EBITDA leverage was elevated as a result of the acquisition of spectrum in the 3500MHz auction in 2021, and increased spending in 2021 and 2022 on fiber, including fiber to the home, and 5G network deployment. Although the spectrum acquisitions and robust network build have pressured leverage, Fitch believes the investments will enable TELUS to maintain a strong competitive position.
To mitigate the pressure on the capital by its network spending and acquisition, TELUS has issued a substantial amount of equity, raising more than CAD4 billion of equity in 2020 and 2021, including subsidiary shares sold. Other steps taken include the sale of non-core assets, such as its Financial Solutions business in late 2021, and through the issuance of equity via its discounted dividend reinvestment program, beginning in 2020.
LifeWorks Acquisition: TELUS acquired LifeWorks in September 2022 for approximately CAD2.3billion. The transaction was funded on a 50/50 basis between debt and common equity, and TELUS assumed approximately CAD500 million in bank debt, which it refinanced. LifeWorks is a provider of digital health and benefits solutions complementary to the company's technology-oriented vertical, TELUS Health. TELUS's revenues related to health services grew 16% in 2021 to CAD521 million. Pro forma for the acquisition, TELUS Health revenues are expected to exceed CAD1.6 billion in 2022.
TI's WillowTree Acquisition: In October 2022, TI and TELUS announced the acquisition of WillowTree and a USD$1.225 billion transaction, including USD$210 million of assumed debt. The transaction will be funded by approximately USD$125 million in TI subordinate voting shares, the reinvestment by management of approximately USD$160 million in equity, and the remainder in cash. The cash portion, in part, will be financed with borrowings under TI's non-recourse credit facilities, with a new, five-year USD2 billion facility to be put in place at the close of the transaction. The acquisition is expected to close in early 2023.
Capital Spending and Spectrum Investments: Fitch believes TELUS's spending on fiber and spectrum support its longer-term credit profile. Spectrum is a key resource that is largely available to TELUS only through auctions. The company spent a higher than anticipated CAD1.95 billion in the 3500MHz auction in July 2021. TELUS is also likely to participate in upcoming auctions in 2023 and 2024 for 3800MHz and millimeter wave spectrum, respectively.
Derivation Summary
Fitch believes TELUS's business risk profile is very similar to peer Rogers Communications Inc. (BBB+/Rating Watch Negative). Both have strong competitive positions with business profiles that benefit from diversified operations, including leading positions as national wireless operators in the Canadian market and strong regional market positions offering telecom-oriented services to consumers and businesses.
In addition, TELUS has diversified into healthcare, home security, business process outsourcing and agriculture. TELUS has demonstrated strong execution on its strategic initiatives, with growth in its wireless business, high-speed Internet services and IPTV platform. Wireless business growth has been supported by very low mobile phone customer churn.
Financial profiles at TELUS and Rogers are somewhat weak for their 'BBB+' ratings, as both have high leverage primarily due to spectrum acquisitions. In TELUS's case, capex related to fiber deployments also contributed to elevated leverage.
Fitch expects the companies' leverage, which recovered to mid-2x in 2018, will be elevated during the next few years due to further spectrum auctions, even absent considerations for TELUS's recent acquisitions and Rogers' proposed acquisition of Shaw Communications. Fitch expects both will refrain from material share repurchases over the forecast due to the additional expected investments. TELUS issued equity in 2021 to support a material rise in capital intensity over 2021 and 2022 to advance investments in fiber and 5G.
TELUS has similar telecom and video-oriented offerings as its North American peers, but does not compete directly with them. These carriers have much larger scale and more geographical diversification.
Key Assumptions
Fitch assumes consolidated revenue grows in the high single digits and low double digits in 2022 and 2023, respectively, given the close of LifeWorks acquisition in September 2022 and the close of WillowTree in early 2023. The company continues to experience continued strong growth at TI and TELUS Health;
Fitch expects the EBITDA margin to remain in the low-to mid-30% range (Fitch-adjusted calculation which excludes share-based compensation and nonrecurring items) owing to efficiency initiatives;
Restructuring costs are excluded from EBITDA but are included in non-operating cash flow;
Capital spending levels in 2022 is expected to approximate CAD3.475 billion, and decline to CAD2.5 billion to CAD 2.6 billion in 2023. Fitch included placeholders for spectrum auctions over the 2023-2024 period;
Fitch has included placeholders for acquisitions in areas such as TELUS International or TELUS Health; Fitch assumes dividends grow at the low end of the company's 7%-10% target range, with the dividend reinvestment program moderating the cash outflow.
RATING SENSITIVITIES
Factors that Could, Individually or Collectively, Lead to Positive Rating Action/Upgrade
The company could be upgraded if EBITDA leverage is less than 2.7x, combined with continued strong wireless performance and growth in its diversified lines of business.
Factors that Could, Individually or Collectively, Lead to Negative Rating Action/Downgrade
A further downgrade from 'BBB' would result from expectations that EBITDA leverage would be sustained above 3.2x due to a combination of acquisitions and spectrum purchases in the absence of a credible deleveraging plan.
Intensifying competition in the mobile market, pressuring margins and EBITDA.
Best/Worst Case Rating Scenario
International scale credit ratings of Non-Financial Corporate issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579.
Liquidity and Debt Structure
Strong Liquidity: TELUS's financial flexibility is good, owing to its balance sheet cash (CAD1.44 billion of cash at the end of 3Q22), undrawn revolver capacity, CP program and accounts receivable securitization program. The company's objective is to maintain at least CAD1 billion of available liquidity.
TELUS maintains a CAD2.75 billion revolving credit facility maturing April 6, 2026. The financial ratio covenants in the credit facility restrict net debt/operating cash flow of no more than 4.25x and operating cash flow/interest expense of no less than 2x. The revolver backstops TELUS's maximum permitted CAD2.1 billion in CP (the amount fluctuates depending on exchange rates) under its USD1.5 billion CP program. There was approximately CAD1.3 billion (CAD equivalent) of CP outstanding at Sept. 30, 2022, thus, the revolving facility had CAD1.449 billion in net availability.
TELUS also has CAD1.6 billion unsecured, non-revolving credit facility maturing July 9, 2024, which can be used for general corporate purposes. The facility was reduced to CAD1.6 billion from CAD CAD1.9 billion subsequent to the end of 3Q22. As of Sept. 30, 2022, the facility had CAD1.6 billion outstanding.
AR Securitization: The CAD600 million accounts receivable securitization program matures in December 2024, and TELUS had CAD100 million outstanding on Sept. 30, 2022. The program contains a trigger clause, which would unwind the program if TELUS Communications is rated below 'BB' by a Canadian rating agency, although Fitch believes this is unlikely given its current rating level. Fitch assumes that the facility will be renewed prior to expiration.
Maturities: TELUS' 2023 maturities consist of CAD500 million at TELUS. At TELUS International (Cda) Inc., in addition to the amortization of the term loan, the USD250 million component of the term loan matures in December 2022. Fitch expects the company to address the maturity in conjunction with the WillowTree financing. In general, TELUS's maturities are well laddered.
TELUS International Debt: TI has a secured bank credit facility that expires in January 2025; the facility is denominated in U.S. dollars. The revolving facility has two components: a USD620 million facility (TELUS is an approximately 7.5% lender) and a USD230 million facility (TELUS is an approximately 12.5% lender). There are two components to the amortizing term loan: a USD600 million term loan (TELUS is a 12.5% lender) and a USD250 million term loan.
The facility is nonrecourse to TELUS but is included in leverage metrics by Fitch and the company. At Sept. 30, 2022, there was a total of USD718 million (CAD974 million) outstanding on the credit facility due to lenders other than TELUS, and the revolving facility had USD839 million available. Amounts owed to TELUS were USD69 million.
TI has a commitment from a financial institution to increase the facility at TI to USD2 billion, consisting of a US$800 million revolving line of credit and USD1.2 billion n term loans, payable over five years, and subject to the closing of the WillowTree acquisition. Borrowing on the facility will be used to fund a portion of the cash purchase price of WillowTree.
Financial covenants in the TELUS International facility include two quarter-end ratio tests: the quarter- end net debt/operating cash flow ratio test of no more than 4.5x during fiscal 2022 and 3.75x subsequently. The operating cash flow/debt service ratio must not be less than 1.5x. The term loans amortize at 5% annually, with the balance due at maturity in 2025.
Issuer Profile
TELUS is one of the three major telecommunications providers in Canada with 9.6 million mobile phone subscribers, 2.4 million connected device subscribers, 2.4 million high-speed internet customers, 1.1 million residential voice subscribers and 950,000 security subscribers at the end of 3Q22.
REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING
The principal sources of information used in the analysis are described in the Applicable Criteria.
ESG Considerations
Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of '3'. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg.
TELUS CORPORATION 
