Don’t Buy Telus Stock Until This Happens

Telus Corp (TSX:T) is a Canadan telecommunications company that has surprisingly avoided the worst of the bad fortune its peer group has suffered over the last decade. While the stock is down slightly over the last 10 years, it is not down to an extreme degree in that period, as BCE Inc (TSX:BCE) is. Additionally, the company has not taken any dividend cuts in the last five years, a distinction that not all of its peers can boast.

While it looks like a positive that Telus has done no dividend cuts in recent years, the company also appears to be pushing its payout, with a 143.5% payout ratio. That is far 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 may find themselves hoping against hope that the dividend will be maintained, both for the sake of the dividend itself and to avoid a large capital loss like that which BCE incurred after cutting its own dividend.

Canadian telos and dividends: A story 10 years in the making

The last 10 years have been a trying time for Canadian telecommunication companies, marked 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) notwithstanding, it has been a tough time for the industry. The question investors want to ask themselves is, why are the telcos performing so poorly?

The answer has to do with dividends. Big dividend payments have been an issue for Canadian telcos over the last decade. The telco that historically had the highest payout ratio of the big three (BCE Inc) has performed the worst out of the bunch, delivering only a 9% total return. Rogers, which has had the lowest payout ratio, has performed second best, with a 48% payout ratio and price appreciation of about 5%. Telus, which has had a middle of the pack payout ratio, has performed the best, with a 59% total return and slightly negative price appreciation over the last 10 years. Unfortunately, T has the highest ratio of the three today, as it maintained its dividend when BCE cut.

It’s nice to see that Telus has delivered an “OK” total return despite having a high payout ratio. However, the company appears to be pushing it with dividends today. As of the most recent announcement, T stock was paying $0.42 in quarterly dividends, on about $0.32 in quarterly earnings per share (EPS) and free cash flow (FCF) per share. The stock does have an attractive trailing dividend yield of 8.8%; however, BCE also had a monster yield before its recent dividend cut. While it would be nice to think that Telus will keep paying that high yielding dividend in the future, the company’s dividends are running so far ahead of its earnings that the situation looks unsustainable. Based on BCE’s experience, we’d 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 cut, then buy

Over the last 10 years, Telus has been the best performing Canadian telco, with a 59% total return. However, it’s beginning to look like some of that run has been unsustainable. Dividend stocks that cut their dividends tend to experience large capital losses, as investors digest the effects of lower dividends going forward. However, when companies have unsustainable payout ratios, such cuts are exactly the medicine they require. So, Telus may need to put its current investors through short-term pain for long-term gain.

For this reason, I think would-be Telus investors should wait for a dividend cut before buying the stock. Should such a cut materialize, the stock would probably fall precipitously in price, providing an attractive entry price and more sustainable dividends going forward. In the meantime, those wanting to play Canadian telcos could consider Rogers, which has a sustainable 40% payout ratio and a much better 10-year EPS performance than Telus, whose 10-year total return seems to have been propped up by unsustainable dividends.

The post Don’t Buy Telus Stock Until This Happens appeared first on The Motley Fool Canada.

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More reading

• Where Will BCE Stock Be in 5 Years?
• Invest $10,000 in This Dividend Stock for a Potential 10% in Total Returns
• Here’s the Average Canadian TFSA at Age 45
• TSX Today: What to Watch for in Stocks on Friday, January 30
• Top Canadian Stocks to Buy Under $50

Fool contributor Andrew Button has no positions in the stocks mentioned. The Motley Fool recommends Rogers Communications and TELUS. The Motley Fool has a disclosure policy.