Fitch Ratings has placed TELUS Corp.'s and TELUS Communications, Inc.'s 'BBB+' Long-Term Issuer Default Ratings (IDRs) and the ratings of their senior unsecured debt on Rating Watch Negative.

The Rating Watch Negative reflects the potential effect on TELUS's credit profile from the definite agreement to acquire LifeWorks, Inc.

TELUS's current gross leverage has been elevated due to recent spectrum investments and increased spending on fiber and 5G network deployment. Fitch expects pro forma gross leverage to approach mid-3x at close and trend downward toward 3x by the end of 2024.

Fitch expects to resolve the Rating Watch upon the close of the transaction, expected in 4Q22, following LifeWorks' shareholder approval and customary regulatory approvals. The final rating action will depend on Fitch's additional analysis of the transaction, including the effects of conditions, if any, placed on the transaction via the regulatory approval process. A downgrade would be limited to one notch; if the transaction does not close, pressure on the rating could remain given the current leverage profile.

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. The ratings are supported by substantial issuances of equity to fund investment programs.

LifeWorks Acquisition: 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.

TELUS is expected to finance the approximately CAD2.3 billion on a 50/50 basis between debt and common equity, and assume approximately CAD500 million in bank debt, which TELUS is expected to refinance. The transaction is expected to close in the second half of 2022, following LifeWorks' shareholder approval and other customary approvals.

Elevated Leverage: Fitch expects gross leverage to be over 3x in 2023 and trend down to approximately 3x in 2024 due to the LifeWorks acquisition and as a result of recent spectrum investments, including the acquisition of spectrum in the 3500MHz auction in 2021, and increased spending in 2021 and 2022 on fiber 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.

Strong Operational Performance: Revenues grew 9% in 2021, and Fitch expects revenues to grow in the low single digits in 2022 and 2023 due to continued solid operational performance and the LifeWorks acquisition. EBITDA is expected to grow 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.

Capital Spending and Spectrum Investments: Fitch believes TELUS's spending on fiber and spectrum support its longer term credit profile. The company completed a CAD1.3 billion equity offering in March 2021 to fund an accelerated fiber and 5G investment strategy over 2021 and 2022, with the accelerated investment leading to an earlier reduction in capex in 2023 than previously anticipated.

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 proposed acquisition of LifeWorks 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 European peers, but does not compete directly with them. These carriers have much larger scale and more geographical diversification. The greater scale and geographically diversified portfolio enable higher leverage capacity for their ratings sensitivities compared to TELUS.

Key Assumptions

Fitch's Key Assumptions Within Our Rating Case for the Issuer Include

--Fitch assumes consolidated revenue grows in the low double digits in 2022 and 2023, as the LifeWorks acquisition closes around the last quarter of 2022, and due continued strong growth at TI and TELUS Health;

Fitch expects the EBITDA margin to remain in the 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 CAD3.4 billion, and decline to CAD2.5 billion (or lower) in 2023. Fitch included placeholders for spectrum auctions over the 2023-2024 period.

The auction timing and rules are subject to uncertainty, and can affect the bidding level;

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:

Positive actions are not expected in the near term given the agreement to acquire LifeWorks and the company's current elevated leverage profile.

Factors that could, individually or collectively, lead to negative rating action/downgrade:

The transaction and current leverage profile is likely to lead to a one-notch downgrade. A further downgrade from 'BBB' would result from expectations that gross leverage would be sustained above 3.2x due to a combination of acquisitions and spectrum purchases in the absence of a credible deleveraging plan.

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 (CAD774 million of cash at the end of first-quarter 2022), 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 in May 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 CAD1.9 billion in CP under its USD1.5 billion CP program. There was approximately CAD1.4 billion (CAD equivalent) of CP outstanding at March 31, 2022.

On a pro forma basis, the CAD2.750 billion revolving facility had CAD1.336 billion in net availability. The CAD600 million accounts receivable securitization program matures in December 2024, and TELUS had CAD100 million outstanding on March 31, 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.

TELUS obtained CAD1.9 billion in incremental bank lines to add to its capacity to finance the transaction.

TELUS repaid TELUS Communications' CAD249 million maturing in April 2022; and 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. In general, TELUS's maturities are well laddered.

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 March 31, 2022, there was a total of USD815 million (CAD1.009 billion) outstanding on the credit facility due to lenders other than TELUS, and the revolving facility had USD749 million available. Amounts owed to TELUS were USD83 million.

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 9.3 million wireless phone subscribers, 2.1 million connected device subscribers, 2.3 million high-speed internet customers, 1.1 million residential network access lines and 830,000 security subscribers at the end of 1Q22.

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

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