Investors: Think Twice Before Investing in Telus Corporation

For investors who’ve sought out and bought shares of dividend-paying Telus Corporation (TSX:T)(NYSE:TU) since the recession of 2008/2009, expectations have clearly been met.

The telecommunications company is in the business of providing access to mobile phones and the internet to businesses and consumers. It can to be categorized as a defensive business.

What resulted from the recession of almost a decade ago was significantly lower rates of interest, which have served to benefit many companies that use high levels of debt.

Putting aside the idea of increasing debt to buy back shares, the benefits of lower interest expense have reached the bottom line due to the savings. As interest rates declined, so did the cost to finance borrowings and expansions for companies wishing to undertake new projects.

As investors are the ones most often willing to lend money to companies through the purchase of bonds, it is important to note that the lower rates to finance debt has translated to lower returns for investors of fixed-income securities.

For every dollar of savings, there is someone on the other side who is giving up the dollar (of returns). Although many investors have chosen to accept the lower rates, it is important to note that for those who did not, the attractiveness of a 4% dividend yield may no longer be enough to keep them invested in their security of choice.

Telus currently pays a dividend which yields close to 4.4%. Although the company bears much more risk than the risk-free rate of return, it is still important to make the comparison.

Over the past month, government of Canada debt securities with a maturity between one and three years have started paying close to 1.25% — up from approximately 0.75%. Clearly, with an increase in overnight rates, investors are beginning to demand much higher returns on fixed-rate investments.

One month ago, shares of Telus traded as high as $45.82, translating to a yield of 4.27%. At this time, the difference between the dividend yield and the risk-free return for one- to three-year government securities was approximately 3.5%.

Since rates have increased, the share price has declined, resulting in a higher dividend yield. Currently, the difference is approximately 3.15%. Shares may need to decline further for the security to become attractive yet again.

Although the investment process is more complicated than simply comparing the excess return offered by dividend payments, it is important to understand why certain companies will respond in a much more direct way to fluctuations in interest rates.

In the case of this telecommunications company, investors are receiving less excess returns in the form of dividend payments alone. The higher borrowing costs for the company, which are likely to creep in over the next few months (albeit very gradually), may take much longer to be felt by equity investors.