Are Canadian Telecoms The Best Boring Businesses on Earth?

One of the more interesting thing about focusing solely on Canadian stocks is the difference between certain industries here and the same industries around the world.

Banking is a great example. There are thousands of banks in the United States with some as small as a single branch. This competition is a good thing for consumers, who benefit from more competition in the marketplace. But it’s bad news for investors. Thus, any stock screen for cheap companies (on a price-to-book value basis, anyway) is dominated by dozens and dozens of small regional American banks with crummy earnings, virtually nonexistent growth prospects, and management with the charisma and vision of a nine iron.

Canada’s banks are much different, of course. The riskiest mortgages are insured by well capitalized insurers, with the federal government owning the largest insurer. There’s also an implied guarantee that the feds will protect the banks in case the you-know-what ever hits the fan, as it did in 2008. Excessive regulations tend to limit competition coming into the market too, although a cynic might argue Canada doesn’t have any new banks because the sheer dominance of the Big Five make it virtually impossible to get started.

The five largest Canadian banks are stalwarts in most portfolios for just those reasons.

I also wrote about which one is my favourite just a few weeks ago. I recently bought a little more of this stock, too.

Canada’s telecoms are similar. The existing big three (Telus, Rogers, and Bell, for those of you new here) control some 85% of the market nationally. There are some smaller local players, but they end up inevitably being gobbled up by the three incumbents. In fact, the fourth largest (that would be Shaw) is in the process of being purchased by Rogers. It’s tough to compete in such a world, so capital does the smart thing and goes somewhere else. Literally. Anywhere. Else.

That’s bad news for consumers — Canadians pay some of the highest wireless rates in the world, or so the common refrain goes — but excellent for greedy bastards investors like me. You have two options. You can either complain about it as a consumer or you can join the party and add these companies to your portfolio. Take it from someone who did the latter — it’s a lot more fun. Especially when your dividends cover your cell phone bill (and then some).

Let’s take a closer look at the larger telecoms in Canada and I’ll reveal my top pick in the sector.

Rogers

Let’s start with Canada’s wireless leader, Rogers Communications (TSX:RCI.B).

Rogers has more than 10 million wireless customers, with that portion of its business accounting for approximately 60% of its revenue. Its cable business is a distant second, with it generating a little less than 30% of total top line sales. Rogers also has a media division, which is highlighted by ownership stakes in various sports franchises, including ownership of the Toronto Blue Jays and partial ownership of the Toronto Maple Leafs. The media division also owns various television channels.

Rogers recently made headlines for a massive internet outage that wasn’t resolved for the better part of a day. This is just a short-term issue, of course, but it’s going to end up costing them a decent chunk of money. This is just the latest of various issues surrounding Rogers, including a family boardroom squabble that would have been interesting if it wasn’t so sad and the company’s tepid earnings growth as it struggled on improving its debt-laden balance sheet.

Take a look at this chart. Yikes.

Shares aren’t really even cheap today. Earnings are a little more than $3 per share. The stock trades at $60 today. That’s 20x earnings. Yawn. Things get a little more exciting if you believe analyst estimates going forward, which have earnings at $3.84 per share in 2022 and $4.35 per share for 2023, but based on the last decade there’s little reason for investors to believe the optimism.

Besides, there’s a big elephant in the room, and that’s Rogers’ attempted takeover of Shaw Communications for some $20 billion and change. On the surface, the merger makes all sorts of sense. Rogers is big in eastern Canada, Shaw is big in the west. Shaw is basically incinerating capital by trying to grow its wireless business, which is scheduled to be sold if the acquisition is approved by the feds. If the deal gets kiboshed, expect both Rogers and Shaw shares to slump on the news.

One look at Shaw’s shares give us some insight on what the market thinks of this deal. The bid was for $40.50 per share. Shaw’s current price is $34.80. Enough said.

Overall grade: C. I do own a little and am content to hold and see if the deal happens. But even then, I’m not overly optimistic on Rogers. The company has lagged for a while now.

Telus

Telus Communications (TSX:T) has long been the favourite telecom among Canadian investors, and it’s easy to see why. It has delivered earnings growth, dividend raises every six months for years now, and has a much different diversification plan than its two peers.

Let’s throw up Telus’s earnings growth chart. It’s slightly better than Rogers, but not as good as you’d think.

The trend is in the right direction, at least.

Telus is not quite as cheap as Rogers on a trailing basis, with shares trading hands at a little more than 23x trailing earnings. Like Rogers, the P/E ratios get more attractive going forward, with analysts estimating Telus will earn $1.24 in 2022 and $1.45 per share in 2023. That puts Telus today at 20x 2023 earnings which, frankly, isn’t very exciting. Especially when there are other, cheaper telecoms out there.

Investors are willing to pay a premium for a couple of things. Firstly, here’s a chart of Telus’s dividend growth over the past decade. It’s stellar.

Astute readers will notice Telus’s dividends are rapidly approaching its earnings per share, which may end up being the signal that ends this trend.

Investors also like Telus’s diversification efforts. The company is expanding into areas such as health care and agriculture, using its existing network and expertise to help those industries. It also has a 65% stake in Telus International (TSX:TIXT), which offers software services and customer support for various tech companies. These are interesting high growth verticals, at least compared to the low growth diversification efforts of Rogers and BCE.

Overall grade: B-. Clearly better than Rogers but I’m not buying Telus here. I’m content to hold. I don’t think the somewhat tepid earnings growth justifies such a high valuation. I’d like to see a pretty significant sell off before adding.

BCE

BCE (TSX:BCE) was formed about 20 minutes after Alexander Graham Bell invented the telephone and started paying a dividend about 20 minutes after that (author’s estimate, reality may slightly differ), two stats which has earned the company a special place in many dividend investors’ hearts.

It has spent much of the last decade gobbling up small regional telecoms it didn’t already own. First was Bell Aliant, which the parent bought the part it didn’t already own in 2014. Next was Manitoba Telecom, which was purchased in 2016. Your author owned a bunch of Manitoba Telecom at the time, happy to collect the fat dividend while waiting for the inevitable acquisition. That worked out just fine.

BCE has also been pursuing a similar media-driven diversification strategy like Rogers. It owns part of MLSE as well, the parent company of the Toronto Maple Leafs. It also owns a portion of the Montreal Canadiens and various television channels and radio stations, things that still exist in 2022.

Like Telus, BCE’s big draw is regularly increased dividends. Let’s take a look at that chart first:

The dividend growth isn’t nearly as high as Telus, which has increased its payout by about 8% annually over the last decade, but it checks in at around 5%. That’s solid, if unspectacular.

The chart for earnings per share looks a lot like Rogers, actually. The earnings are consistent, but growth isn’t really there. The current P/E ratio is 21x with earnings expected to increase from $2.99 per share in 2021 to $3.42 in 2022 and $3.44 in 2023. Not bad, but certainly not exciting.

Your author certainly expected more consistent EPS growth from these companies. This has been a little eye opening.

Overall Grade B-. Similar to Telus. BCE’s higher dividend yield (5.8% compared to Telus’ 4.7% yield) helps but ultimately I’m pretty meh about buying a company with tepid earnings growth today for greater than 20 times earnings.

Cogeco 

Many investors outside of Southern Ontario haven’t even heard of Cogeco (TSX:CGO), the cable operator who focused on markets outside of the Greater Toronto Area and various rural parts of Quebec. It’s a strategy that worked pretty well in Southern Ontario as the population moved away from Toronto proper and settled into the suburbs.

The company has been active acquiring assets in the United States, using a similar strategy as in Canada. It operates in cities like Cleveland, Columbus, Miami Beach, and New London. These smaller assets combine to make it the 8th largest cable operator in the United States.

This growth strategy has had some pretty good results. Here’s a snapshot of the last 10 years of revenue and profit growth.

A few missteps there, but the trend is pretty clear. We get an even better picture when we look at EPS.

No, that’s not a typo. EPS increased from $1.29 to $8.87 per share over the last decade.

Dividend growth? You know it. Check this out:

Dividend tripled in the last decade, which translates into about a 12% growth rate. Not bad at all. The payout ratio is approximately 25% of earnings, which is much better than Cogeco’s peers. That translates into oodles of dividend growth potential going forward.

Cogeco is cheap as well. It earned $8.87 per share in fiscal 2021 and $9.15 per share TTM. Shares currently trade hands at just over $68 each. That puts it at about 7.5x trailing earnings.

It’s one of the cheapest stocks in Canada.

Why the huge valuation difference between Cogeco and the other telecoms? A few reasons, actually. Firstly, everyone knows the Big 3. Lots of investors couldn’t give two rips about some regional cable operator that also happens to offer home internet.

Investors also think cable is going away forever despite it continuing to be a pretty solid option in a streaming world. I pay for Netflix, Amazon Prime, Sportsnet, and TSN, and it comes to about $60 per month. A basic cable package doesn’t cost much more than that. Cable operators have been successfully raising prices higher than inflation for decades now. And there are still a ton of boomers out there who can’t survive without having Fox News or CNN in the background.

The other big reason why Cogeco trades at such a discount is the parent/subsidiary relationship. All the numbers I’ve been quoting are Cogeco Inc., the parent company. There’s also Cogeco Communications (TSX:CCA), which only owns the cable assets. The parent owns a chunk of Cogeco Communications as well as Cogeco Media, which consists of 20 radio stations in Quebec and one in Ontario. They’re basically the same company with a needlessly complicated ownership structure.

Such a structure generally ensues the parent stays cheap until it takes the logical step of buying out the subsidiary. Cogeco owns 34% of the equity of the subsidiary, so that might be a bit of a challenge in the near-term. But it also underlines the compelling opportunity.

Cogeco has a market cap of $1.07B. Communications has a market cap of $3.94B. The parent owns 34% of the subsidiary, yet it trades at just 27% of the market cap. Combine that with the low P/E ratio and the dividend growth potential and I like the stock today. Plus it comes with a 3.7% yield.

The bottom line

Your author owns all four stocks mentioned in this article. Yet he’s only actively buying more Cogeco today. That’s a pretty good endorsement.

Valuation matters. Wait to buy the big telecoms until they’re unwanted again. It’s really that simple.

Author owns Telus, BCE, Cogeco, and Rogers shares, ranked by portfolio ranking.