Many of the biggest names in tech have tumbled this year. That’s led some investors to give traditional telcos a second look. Greg Bonnell speaks with Monica Yeung, Global Communication Services Analyst, TD Asset Management, about the outlook for the communication sector.
- The big tech names, Netflix, Facebook, among a whole group of them that were rage among investors during the pandemic. They've been on the back foot this year, and the traditional telcos actually coming back into vogue-- investors searching out, perhaps, some more defensive plays.
Joining us now to discuss this change of fortunes, Monica Yeung, Global Communication Services Analyst at TD Asset Management. This is an interesting one, Monica. Thanks for joining us. Walk me through this in terms of the traditional telcos, perhaps getting a second look.
- Yeah, it's been a really interesting year so far in 2022. I think it's helpful for a moment just to zoom out a bit and understand what constitutes the communication services sector, which is the sector that I cover as an analyst. And it's actually a really interesting basket of stocks.
On one side of the spectrum, you have very traditional mature business models, the likes of the traditional media companies and television companies, telcos, cablecos. These are business models that typically grow in the low single digits, in some cases flat to even declining. And on the other side of the spectrum, you have arguably what are tech companies, these high-flying secular growers, the likes of the online media streamers like Netflix, the big internet names like Facebook and Google.
And I call it a tale of two cities, a reversal of fortunes, if you will. Because, for the last decade, if you had just bought that second basket of stocks, you would have made a lot of money compared to the index. The reality is, is that trade just has not worked in 2022.
We have names like Netflix down 70% year to date. We have names like Facebook down 50% year to date. And on the other side of the spectrum, in contrast, we have these sleepy, kind of boring telcos, things that people haven't paid attention to for a long time, the likes of AT&T and Verizon in the US, Telus, Rogers, and BCE in Canada. These names are relative winners this year. They're flat, even slightly up in a bear market.
- I know you're looking, too, at the dispersion of returns in the space. Explain that to me and tell me what you're seeing.
- I think it's important to understand some of the drivers of why we're seeing names down 70% and other names maybe flat to slightly up. And, you know, there are two reasons that really stand out to me. The most obvious, I think, is a shift in the way people are choosing to spend their time post-COVID.
So, March of 2020, all of us were locked down at home. There wasn't a lot of things to do, places to see. And so, as you would expect, we saw a huge massive surge in demand for online services. Lots of people signing up for new Netflix accounts, spending more time on their social media apps, like Facebook, or TikTok, or Instagram.
Two years later, we're now shifting from this digital verse into the real verse, if you will. People are interested in experiences. They want to go out and see a movie, have dinner with friends, travel. And that's really been at the detriment of the higher growth secular growth.
So people just aren't watching Netflix the same amount that they used to. They're spending less time scrolling through Instagram. There are less eyeballs on the screen, and so that's what's really driven some of the weakness in these stocks.
The other factor that explains some of this diversion, I think, is just the macro environment. It's changed much quicker than anyone would have anticipated this year. And that's had kind of two effects. One is that it's brought down valuations on growth stocks with rates higher. Also, however, people are now searching for defense. There's this huge appetite for defense in potential recession fears. Telcos have traditionally offer that.
- Suddenly, sleepy gets a little more attractive.
- Exactly. Telcos pretty resilient in a recessionary scenario. Their profitability and revenue holds up pretty well. And I think that explains why there's been support under some of these names so far.
- Recession fears obviously are looming large over the market. So you talk about how that favors the traditional telcos. Let's talk about some of the names like Facebook, Google, and Snap, Twitter. They rely on advertising. What happens to them if we did fall into recession?
- It's a great point. They're tech companies, but most of their revenue really comes from advertising. I would say advertising in general, whether it's online advertising or traditional on screen advertising, it's very, very sensitive to an economic environment.
So if you have a situation where GDP is down 2%, the total advertising pie is down some multiple of that. We can look back into history as a guide. So if we look at 2008, Google at that time pre-recession was growing at a clip of 40% per year. In Q2 of 2008, that fell to 5%. So we saw 35 point spread, basically a slowdown in their growth.
Today Google is growing mid-teens. Not inconceivable, if we hit a moderate recession, that that could go flat, maybe even slightly negative. So these are great, long-term secular business models, but definitely not resistant or immune to any recession.
- Let's talk about the Canadian telcos, relative winners so far this year. What's your thought on the space, the current valuations? And I think you have a chart that you brought along for us that we can speak to on this one.
- Yeah. I mean, I go to a couple of things. We talked a little bit earlier around the search for defense, so that's definitely helped. Also, however, it's been a pretty good fundamental backdrop. And so what do I mean by that?
Canadian telcos have a bit of a reopening place. So as more people travel, you see an uptick in roaming revenue. And that is good for top line growth. Also, as borders reopen, more students coming into Canada, more immigration, good for population growth, good for subscriber growth.
And the last thing I'd note is that the competitive environment has been quite favorable. In the past, we've seen very aggressive promotional periods where Rogers, Telus, BCE have gone head to head with heavy, heavy handset subsidies, for example. We haven't seen that for the past year. So search for defense, good fundamental story. And then I guess the only give, really, is the valuation.
- Well, let's show that to the audience again. We were showing it to them now. We can walk through exactly what it is, telling our audience what it's telling us about some of these names. So Canadian Telco Valuations-- walk us through this.
MONICA YEUNG: Yeah. So this shows EV to EBITDA multiples for the last decade for the average of the Canadian telcos. And what you can see is that we're trading one standard deviation above the long-term average, so definitely at the top end of the range. That gives you a bit of caution. But, at the same time, if we continue to have recession fears and we're in a bear market, there's likely support under these stocks for a while.