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2007 Targets investor conference call - Robert McFarlane presentation
Operator: Good morning, ladies and gentlemen. Welcome to the TELUS 2007 targets conference call. I would like to introduce your chairperson, Mr. John Wheeler, Vice President of TELUS Investor Relations.
John Wheeler: Good morning and thank you for joining us today for our investor call focused on key financial and operating targets for 2007. A news release was issued earlier this morning. The release and the slides for this call are available in the investor section of the TELUS website under TELUS.com/investors.
The format for today's call will be opening comments by Executive Vice President and CFO, Bob McFarlane. This will be followed by a full question-and-answer session. We expect to complete this within the hour allotted.
Let me now director attention to slide 2. The forward-looking nature of this presentation, answers to questions, future financial results, and 2007 targets are subject to significant risks and uncertainties and assumptions. Accordingly, TELUS's actual results could differ materially from statements made today. So do not place undue reliance on them. I ask that you read our legal disclaimers and refer you to the risks and assumptions outlined on this slide, our 2007 targets news release issued today, and our public disclosure and filings with securities commissions in Canada and the United States. I will now turn the call over to Bob and refer you to slide 3.
Bob McFarlane: Thanks, John, and thanks to everyone listening on the phone and on the Internet for making time to join us during this very busy time of year. As shown, the agenda provides an update on our existing 2006 guidance and the recent regulatory development on forbearance, a detailed review of our 2007 targets, as well as a few brief summary comments to conclude.
Turning to slide 4, today we are announcing four updates to our 2006 guidance while reaffirming the other 11 items. Our guidance was last updated on November 3 in conjunction with the third-quarter results. Our outlook for capex is increasing slightly to approximately $1.625 billion driven by a higher outlook for wireline capex. We're now on track to hit the high end of our existing guidance range for our nonincumbent EBITDA of approximately $30 million. In addition, we now expect full-year wireless net additions of approximately 550,000.
Turning to slide 5, let's summarize for you the current updated wireless guidance compared to the original targets for 2006, which we set at this time last year. As you can see, we expect to meet or do better than our original with revenues significantly exceeding our original target. This reflects the growth and financial performance of both the Canadian wireless industry and, of course, at TELUS. As just mentioned, we now expect our wireless net additions to approximate 550,000, as compared to our original target of more then 550,000.
On slide 6, we compare our latest 2006 guidance for wireline versus the original targets. This is also notable, with four out of six items either achieving or exceeding original targets, while we still have a shot at achieving the low end of our original revenue target. This shows the resilience for our wireline operation and the ongoing successful execution of our national data focused strategy.
We expect capex to be higher than our original target. This reflects strong housing growth in Western Canada as well as greater investments in growth areas to support the business for the future, including broadband expansion and internal IT systems.
Slide 7 compares our latest guidance to our original targets on a consolidated basis. We are on track to meet our original targets with respect to revenue and EBITDA, with significant outperformance on EPS. Notably, although capex is now expected to be higher than the original target, we continue to expect to generate strong free cash flow levels.
As shown on slide 8, there was a major regulatory development this week with the announcement by Industry Minister Bernier of a new regulatory forbearance policy. We're pleased with the direction the government is going as it adheres to the Telecom Policy Review Panel's primary recommendation. Namely, that it is now time for meaningful deregulation and to allow the competitive market forces that exist today to regulate behavior in our industry as the first step.
We think the changes proposed in areas of the competitive test, elimination of winback restrictions, size of geographic areas, and quality of service indicators are much more realistic. They recognize the competition that is clearly at work in most of our major markets. This is a positive development for Canadian consumers and our industry that should allow the market to determine outcomes and foster enhanced innovation and investment in our industry. Based on the government timelines and the proposed process, we expect that we could obtain forbearance in major urban ILEC markets in the second half of 2007.
Now with that, let's turn to TELUS's targets for 2007 starting on slide 10. Let me begin by covering certain important assumptions that underlie the 2007 targets on the next two slides. We expect economic growth to be consistent with the Conference Board of Canada projections. That is, GDP growth of 3% for Canada, with provincial growth rates ranging between 2.5% to 4% in the four main provinces in which we operate -- BC, Alberta, Ontario, and Quebec. We expect increased competitive activity from cable TV and IP telephony players in both the consumer and business markets. We expect the Canadian wireless industry penetration growth to remain strong and be similar to that expected in 2006, within the range of 4.5% to 5%.
On the regulatory front we are assuming that the CRTC's price cap regulatory review should end the annual local consumer price decreases and, as mentioned earlier, that we could see local forbearance in major urban markets in the second half of the year.
We are projecting that we will have approximately $50 million of restructuring and workforce reduction costs in 2007. We expect that the actuarial pension assumptions will remain unchanged and, from an accounting perspective, the discount rate of 5% and the assumed investment return of 7.25% will be unchanged.
Continuing on the next assumptions slide, depending on the number of shares repurchased as part of our new Normal Course Issuer Bid, or NCIB, we expect average shares outstanding to be lower, in the range of 330 million to 335 million next year. This also reflects the impact of our new cash settlement method for option exercises that I will explain momentarily.
We are expecting a blended statutory tax rate of approximately 34% in 2007. Notably of investor interest is our new view on cash tax payments. Based on an updated analysis of our tax loss position and tax impacts of the new option cash settlement program, we now expect minimal cash tax payments in 2007, circa $100 million of estimated cash tax payments in 2008, with the payment of more significant cash taxes being deferred to 2009, which is one year later than previously expected.
We have two additional items to update you on. As mentioned earlier, in 2007 TELUS is introducing the cash settlement method for all outstanding vested or soon-to-be vested options. Settling the in-the-money value of options for cash when a holder elects to exercise their options is a tax-efficient way to avoid shareowner dilution from options by eliminating the issuance of shares in treasury.
At the same time, the cash payment would be tax deductible for TELUS, yielding potential cash tax savings of approximately $70 million over three years, as cash payments are deductible for tax purposes when the options are exercised and paid out. The accounting result would be an increased non-cash compensation expense of an estimated $200 million pretax and an EPS impact of $0.40, the bulk of which is expected to be recorded in the first quarter of 2007.
The incremental pretax operating expense will likely be split somewhere along the lines of $150 million in wireline and $50 million in wireless. The Company intends to substantially hedge the mark-to-market accounting variability risk as it has done in the past for our compensation such as RSU grants.
Secondly, on slide 13, we are revising our definition of net debt to include 100% of our securitized accounts receivable program in order to be consistent with rating agency treatment. Formerly, we included 0% in our net debt calculations. As an example of what kind of impact this would have, if you included the $350 million outstanding in securitized accounts receivables as at September 30, our net debt to EBITDA ratio would have increased from 1.6 to 1.7 times. Similarly, at the end of the third quarter, net debt to total cap would have been about 48%.
We have left our long-term leverage policy targets of net debt to EBITDA of 1.5 to 2.0 times, and net debt to total cap of 45% to 50%, unchanged. Given the definitional change to debt, the policy targets are effectively slightly more conservative than previously.
So based on these key considerations and assumptions, which are of course subject to some risks and uncertainties, let's turn to slide 14 and look in detail at our 2007 targets for wireless. As you can see here, our wireless revenue target for 2007 is 4.325 to $4.375 billion, representing excellent growth of 12% to 13%. This revenue target reflects continued strong subscriber growth and the maintenance of our industry-leading ARPU by providing a value-added customer proposition. Continued wireless data revenue growth supports our outlook, as well as the pending 2007 launch of Amp'd Mobile, powered by TELUS.
As highlighted on slide 15, we are targeting to add more than 550,000 new subscribers in 2007 or approximately the same level as in '06. This would represent an expected 11% increase in our wireless subscriber base to more than 5.6 million subscribers.
With continued Canadian wireless market growth in 2007 of 4.5 to 5 points, we see the industry on track for another year of healthy subscriber net adds; and we will strive to obtain our fair share. However, it is apparent from recent developments that competition remains intense as flanker brands cut prices and other resellers, including cable operators, enter the market, while established value brands continue to compete vigorously.
On slide 16, TELUS's wireless EBITDA is illustrated both including and excluding the cash settlement for option expense impact of $50 million. When normalized for this nonrecurring item, wireless EBITDA is expected to increase 12% to 15%. Our 1.95 to $2.0 billion target again reflects our long-standing focus on profitable subscriber growth and cash flow generation, with an overriding focus on generating a superior return on our significant wireless investments to create considerable shareholder value.
Slide 17 depicts that on a normalized basis EBITDA margins as a percentage of total revenue are expected to remain solid in the 45% to 46% range, as shown on the chart on the right.
Turning to slide 18, we are targeting wireless capex of approximately $550 million in 2007. Included in this amount is further expansion of our EVDO coverage and provisions for expenditures related to RevA. Although an increase from 2006, in relation to total revenue, our capital intensity of 12.6% remains quite low.
Solid expected margins of 45% to 46% combined with low capex intensity results in an impressive expected cash flow yield of 32% to 33%, which remains best in class when compared against our large North American peers. This is a very important valuation consideration given TELUS's significant exposure to wireless.
Turning to the wireline segment, starting on slide 20, wireline revenue is expected to increase 1% to 2% in 2007. This reflects the impact of data growth, including new revenue streams from our Future Friendly Home initiative, along with non ILEC growth, somewhat offset by increased competition particularly in the consumer ILEC business as well as the continuing trend of wireless and Internet technological substitution of traditional wireline voice services. This later trend does not help our wireline results, although it should be emphasized we derive a net benefit from wireless substitution on a consolidated basis.
Turning to slide 21, you can see TELUS's wireline EBITDA both before and after the cash settlement option expense impact of $150 million. The chart on the right hand shows our wireline EBITDA target for 2007 excluding the cash settlement option expense. This normalized wireline EBITDA is expected to be down 1% to 3%, generating between 1.775 to $1.825 billion. This reflects the effects of continued competitive activity, which TELUS expects to experience in 2007; our ongoing efficiency program; as well as earnings dilution from certain growth initiatives.
We intend to keep obtaining the majority share of high-speed Internet net additions in 2007 as we have in 2006. Slide 22 shows that we are continuing to expect strong high-speed Internet net adds in 2007, targeting more than 135,000. This represents an anticipated 15% increase in our high-speed subscriber base, which means more than 1 million total subscribers by the end of 2007.
Concluding the wireline segment on slide 23, wireline capital expenditures are expected to remain flat at $1.2 billion. TELUS continues to make significant investments in network infrastructure to improve broadband capability, enhance our customer service, and develop new applications, and make investments in our internal systems and processes, as well as making success-based investments to support new contract wins.
So what does all of this mean on a consolidated basis? As you can see on slide 24, we are targeting a 2007 revenue increase of approximately $550 million or a robust 6% to 7% growth rate, driven mostly by wireless and more modestly by wireline. This slide illustrates the continued significant upward growth trajectory of our consolidated revenue over the last four years.
Slide 25 shows that, excluding the nonrecurring non-cash cash settlement option expense of $200 million, our consolidated EBITDA target translates to healthy growth of 4% to 7% year-over-year. This builds on our track record of strong underlying EBITDA growth in the business.
Looking now to EPS on slide 26, at first glance after three years of growth reported EPS appears to be down in 2007. However, turning to the next slide, let's look at the details of the underlying year-over-year change.
Slide 27 provides more detailed illustration of the incremental line items affecting 2007 EPS. Guidance for 2006 EPS is $3.15 to $3.25, which includes the $0.42 of positive year-to-date September tax-related adjustments. This results in a normalized 2006 EPS of roughly $2.73 to $2.83, depicted by the midpoint of the range at $2.78.
Our projected 2007 EBITDA growth provides $0.35 to $0.55 of after-tax EPS growth. We expect lower financing costs as a result of reduced debt levels and lower interest rates on debt refinancing, which provides a 9% impact. In addition, we expect a decrease in the average number of outstanding shares due to share repurchases, which gives a favorable $0.10 to $0.15 boost. Further, the cash settlement for option expense and higher depreciation and other expenses offset this EPS growth by $0.40 and $0.11, respectively. This results in a 2007 EPS range of $2.85 to $3.05, strong growth over the comparable underlying 2006 estimate.
However, normalizing for the after-tax impact from the change to cash settlement for vested options of $0.40, you get our $3.25 to $3.45 normalized EPS target range as depicted on slide 28. So normalized EPS growth, adjusted for $0.42 of 2006 year-to-date favorable tax impacts and the 2007 cash settlement of options, actually is very healthy at 17% to 24%.
Turning to slide 29, let's look at TELUS's free cash flow trend. The graph on the left-hand side of the page shows the free cash flow as reported according to our 2006 methodology. You can see that although not an official target of TELUS's for '07, free cash flow is expected to remain high at 1.45 to $1.55 billion.
The graph on the right-hand side of this slide shows free cash flow according to a slightly modified definition, which now subtracts cash items from the other expenses line of our income statement, which total approximately $25 million in each of '06 and 2007. The cash impact as a result of the option cash settlement affects 2007 free cash flow by about 75 to $125 million. So the midpoint which we take is approximately $100 million, resulting in adjusted free cash flow in '07 of 1.525 to $1.625 billion. Regardless of the way it is presented, you can see robust cash flow remains high as increased capex is funded by EBITDA growth.
Slide 30 summarizes TELUS's 2007 consolidated targets. When looking at these growth rates on an organic basis, it is evident that we expect solid performance in the upcoming year which builds upon our track record of outstanding growth.
Now let me take the time to provide a return of capital update before I conclude. Slide 31 gives you detail on how -- our recent share buyback program activity. Since the last update I provided on our Q3 conference call on November 3, we continued to the active in the market, purchasing 3.1 million shares for $174 million at an average price of $55.19. In total, we have repurchased a total of 17.1 million shares for $832 million, which is 71% of the authorized program. While TELUS's current NCIB ends on December 19, 2006, subject to attaining TSX acceptance, we intend to renew our NCIB share repurchase program for another year.
Further to this, slide 32 summarizes TELUS's ongoing initiatives to return capital and create value for shareholders. The intended renewal of our NCIB program should allow repurchases of up to 24 million shares over a 12-month period commencing December 20 of this year.
As mentioned earlier, we are introducing cash settlement for all vested or soon-to-be vested options. This mitigates shareholder dilution by avoiding issuing shares from treasury.
As you will recall, with our third-quarter earnings release, we announced a 36% increase in the quarterly dividend, $0.375, effective for the January 1, 2007, payment. This is our third successive increase in the past three years. At a $1.50 annualized level, this is a record high dividend for TELUS and is in line with TELUS's Board-approved targeted payout ratio guideline.
The chart on slide 33 shows the impressive trend in return of capital to TELUS shareholder since 2003. In 2005, when one aggregates dividends and share repurchases, we returned $3.30 per share in capital. In 2006, this number is on its way to a neighborhood of $3.52 per share when one adds dividends to projected full-year share repurchases, based on annualizing our year-to-date run rate.
Next year, in 2007, the combination of the higher dividend and significant share repurchases at an amount consistent with our '06 year-to-date run rate would result in a total return of capital to shareholders of a remarkable $3.92 per share. Notably, this is within the range of cash distributions that TELUS stated it would pay out if we had converted to a trust.
So while 2007 figures are for illustrative purposes only, what is clear is that TELUS has a track record and ability to deliver on our commitment to return a significant amount of capital to investors; and we continue to intend to do so.
TELUS has successfully executed on its national growth strategy, predicated on the six strategic imperatives listed on slide 34, which were first set after Darren's arrival in 2000. Once again in 2006, the adherence to this winning strategy, coupled with our strong execution to plan, has enabled TELUS to drive earnings growth and strong cash flow, resulting in our share price again outperforming stock market and telecom indices. Notably, in the face of a global industry, which has experienced tremendous change, TELUS's strategy remains as relevant today as it did in 2000 and will continue to guide our focus into 2007.
To conclude on slide 35, in summary, we have made minor revisions to TELUS's 2006 guidance. Non ILEC EBITDA has been moved to the top end of the original target range. Capital expenditures have been slightly increased. Wireless net adds have been adjusted downward to the lower end of the original target.
2007 targets announced today reflect strong revenue growth driven by wireless; solid normalized EBITDA and EPS growth; continued strong subscriber growth; and focus on our commitment to invest in growth areas. TELUS intends to deliver on our targets for 2007, which are clearly consistent with our growth model for profits and return on capital.
I would be pleased to answer questions now. Let me turn the call back over to John to moderate the session.
Robert McFarlane, executive vice-president and chief financial officer
Question period
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