TELUS CORP. (Toronto symbols T $44 and T.NV $44; SI Rating: Above average) is Canada’s second-largest telecommunications provider, after BCE Inc. It provides local and long distance telephone services to roughly 5 million customers, mainly in Alberta, British Columbia and parts of Quebec. It also provides Internet access services to roughly 1 million subscribers.

Telus’s revenue slipped from $7.1 billion in 2001 to $7.0 billion in 2002, but rose to $8.1 billion in 2005. It lost $0.51 a share (total $145.8 million) from continuing operations in 2001, as well as $0.75 a share ($235.8 million) in 2002, mainly due to restructuring costs following the Clearnet acquisition. However, earnings improved from $0.92 a share ($324.4 million) in 2003 to $1.94 a share ($700.3 million) in 2005.

Most of Telus’s recent growth comes from its wireless division, which is Canada’s largest wireless service provider with 4.5 million customers (36% of the market). The company is also doing a good job of hanging on to its customers, and getting them to sign long-term service contracts.

That’s good news for Telus, since it earns steadier revenues from long-term plans than pay-as-you-go use. In fact, long-term contracts account for 81% of Telus’s wireless customers. That’s better than its two competitors, 78% at Rogers Communications and 74% at BCE.

Wireless still has lots of potential

The outlook for Telus’s wireless operations remains bright. Only 52% of Canadians have a mobile phone, so there’s plenty of room to grow. It’s also unlikely that regulators would grant a license to a fourth national wireless company anytime soon.

Strong growth from the wireless business has helped offset lower profits from Telus’s traditional phone (or “wireline”) operations, which have struggled as cable companies started offering local phone services. Telus is also under fire from new competitors that use Voice-over-Internet Protocol (VoIP) technology to send calls over the Internet.

Right now, regulators prevent traditional phone companies from lowering their prices to match or beat the prices offered by new competitors. Regulators want to give cable and VoIP providers time to build up their customer base, before opening the market to full competition.

Now easier to win back old customers

The traditional phone providers still control over 90% of Canada’s local phone market. That figure has to drop to 75% before Telus can set its own local-service prices without regulatory approval. However, new regulatory rules now let Telus contact customers who switch their phone service after just three months, instead of waiting a year.

As part of its strategy to hang on to local customers, Telus is testing a new TV service that uses high-speed Internet technology to send TV signals over ordinary phone lines. It has already signed up customers in Calgary and Edmonton, and aims to bring this service to more areas this year.

In 2005, a five-month long strike cost Telus $133 million. But a new, five-year union contract gives Telus labour peace, and more flexibility to outsource certain functions.

In 2005, Telus spent $3.69 a share on new equipment and upgrades. About 70% of that went to the traditional wireline business, and 30% went to wireless. Capital spending in 2006 will probably rise 17%, to around $4.30 a share. The company generated cash flow of $2.6 billion or $7.09 a share in 2005, up from $2.5 billion or $6.95 a share a year earlier, so it can easily afford these upgrades.

More cash for dividends & buybacks

The company’s strong cash flow also let it repurchase $892.1 million worth of its stock in 2005. It will probably spend at least that much on buybacks this year.

Telus is also using its strong cash flow to raise its quarterly dividends 37.5%, from $0.20 a share to $0.275. The new annual rate of $1.10 yields 2.4% (2.5% for the non-voting shares).

The stock now trades at 17.6 times (17.2 times for the non-voting shares) the $2.56 a share it will probably earn in 2006. That’s more expensive than the other phone stocks, but reasonable in light of the strong growth prospects and high market share of its wireless business. Telus could also unlock value by spinning off its slower-growing wireline assets into an income trust.

Telus is a buy. The cheaper, non-voting shares are the better choice.