Have Canadian telcos finally put their challenges behind them?

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Canadian telecom sector has been under pressure recently. Our feature guest today says there may be some potential green shoots for the space. Joining us now to discuss, Vince Valentini, Managing Director for Equity Research at TD Cowen. Vince, great to have you back on the show.

Good to be here again, Greg.

So the telecom stock's good. I use a heat map today in Advanced Dashboard to pull up the one-year performance so far. And whether it's BCE, Telus, Rogers, Québecor, they're all feeling some downward pressure. What's going on here?

Yeah, most of them are off 20% or more from their highs last year. It's been almost a perfect storm. I look back at when I was here last time, and I realized that that was-- things basically got a lot worse within a couple of weeks after that. So that was mid-February. First of all, we've seen bond yields go even higher. And as I talked about last time I was here, we need bond yields to start coming down to bring back just some macro interest to the space.

At heart, these are not growth names. They are steady cash flow names with good dividends. So people, when they don't have alternatives in risk-free bonds, they tend to look at these names, and they get better bid and get better valuations. So bond yields are up about 15 basis points since then. So that doesn't create a good sort of starting point.

And then probably more importantly, that is the competition in the industry has just gotten even worse. I'd say we've had, basically, higher for longer in terms of rates, lower for longer in terms of pricing for telecom services, especially when it comes to wireless. In the month of March, so just after I was here last time, things basically went off the rails. We saw price wars across the industry, across most of the country, especially in the province of Quebec, effectively, Rogers, Bell and Telus all saying we are not going to let Québecor and their new Freedom Mobile business just run amok and take market share. And Québecor had kept pricing very low for a long time.

Typically, what we see is Black Friday pricing get pretty aggressive. That'll last through the end of the year and Boxing Week. And then first couple of weeks of January, we'll see pricing creep back higher, giving an opportunity to dip back down again during promotional periods in the subsequent year. We have now been sitting here since November, and Québecor and Freedom have not changed their pricing. We're in the middle of May, and they still have their Black Friday pricing in the market.

So that is really the heart of it, Greg, as to why these things have been so weak, because people think Rogers, Bell, and Telus are going to have to sustain lower pricing and lower ARPU in their wireless business in order to fend off this increased competition from Québecor. That combined with the bond yields has these stocks trading at pretty low valuations, I would say. But there's certainly been justification for it. The news flow has been pretty bad.

Going forward, now, let's start breaking those things down. We are anticipating, or at least the market is anticipating, and pushes it out some rate cuts from the Fed later this year. So let's start with the interest rate environment. If we do end up in a situation where, by the end of the year, the Fed feels they can start cutting its trendsetting rate, would we start to see some relief in these kinds of names?

I think you would for sure. If you just go back to November and December, when bond yields were coming down, these stocks-- at that time, people were still nervous about pricing in the industry. We were in the midst of that Black Friday pricing going on for all the carriers. But it's almost like the market ignored the bad news on the industry fundamentals because bond yields were coming down, and most of the stocks had a pretty good run over that last six weeks to end last year. So I think the same thing will happen again.

The bad news gets overwhelmed by the macro good news on bond yields. Look, let's face it, you're looking at a 7% dividend yield on Telus, 8.5% on BCE. Even if there's a little bit of hair on these names in terms of competition, people are going to find that pretty attractive in an environment where interest rates and bond yields are coming down.

For a full disclosure on the companies covered by TD Cowan, please see the link to the website at the end of this program. So that's the interest rate environment. Let's talk about the competitive environment. You said obviously, the big players aren't going to say, you can price whatever you want, and we'll just step back and let you take market share. Could we see an easing of that competitive space this year?

I sure hope so. But I'll be honest, it doesn't seem like it's going to happen right away. We've just come through earnings season, and we've had conference calls with all of the major operators. Telus and Québecor were both the last to report on Thursday of last week. Québecor was asked numerous times on their call about their pricing strategy, why it's so aggressive, because their numbers in some places were not great either.

They're seeing a significant reduction in their RPU, average Revenue Per Unit, in their wireless business because of the low pricing they have. So people are asking, are you going to let up? Are you going to raise your price a little bit? And their signal was basically, no. We are here to gain market share. We are the disruptor. And the messaging they're giving is a bit scary for some people.

I suspect it'll ease at some point. We always seem to see the pendulum swing back to the middle at some point in this industry. I've gone through periods in my 25 years covering it where we've seen news flow as bad as this and people fearful that a price war will last forever. Rarely will it. At some point, people will-- cooler heads will prevail. I should point out, though, we did see the three incumbents, Rogers, Bell, and Telus, have all moved their price up in April. They've all gone from what used to be $34 for 50 gigs of data is now $39 for 20 gigs of data. And that is on their flanker brands, where they tend to have their more aggressive pricing.

So there has been a bit of a green shoot from them. But Québecor and Freedom have not followed that path higher, which is what we were hoping to see by now, but it's not happening just yet. So I think we probably have to figure out how to value these stocks and what upside there can be, even if pricing-- I don't think it gets a lot worse. But I have to assume it doesn't get better.

Now, we hear from some of these names that the regulatory environment is not favorable for their operations. Let's break that down in terms of, how do you see it in terms of the regulatory environment? And do you think there be any relief coming from the CRTC?

So when I think regulatory, Greg, I would think broader picture to start with, is government efforts on the population growth and the housing growth side. There, there could be some impact, for sure if this government or any future government wants to put further restrictions on foreign students or permanent immigration. That has been a very nice tailwind for the wireless industry. We saw record levels of subscriber growth in 2022 and 2023. So if there is a more substantial reduction in population, I would consider that the biggest regulatory or government risk that we face.

In terms of the specific regulator and the CRTC or Industry Canada, really nothing, and nor should there be. The competition in the market is taking care of all the problems they wanted. Every time the CPI stats come out, a big outlier versus increases in the price of most goods for consumers, a big outlier is wireless down 15% to 20% year over year. Internet prices are not down as much as that, but they're still down low single digits.

So if I'm the CRTC or a politician, I'm probably saying, look, I'm not going to congratulate the telecom industry. It may not win me any votes, but do I really want to make this a focal point? There's a lot of other fish that they need to fry. And I think telecom, they're saying, look, the things we've done in the last decade to create more competition seem to be working on their own. And we don't need to step in and do anything else. So I'm not-- no I'm not worried at all, Greg, about incremental CRTC decisions and just keep our eye on population growth and what the government may be doing there.

You put all this together for the telecom space. Obviously, some investors may feel frustrated if they hold some of these names, and they're wondering what's going on. Longer term, what should they be thinking?

I think you want to focus on the names that have the ability to generate good cash flow, even if we're in a lower-for-longer scenario in terms of pricing. And there are a couple of names that can deliver that and then sustain good dividend growth. So that's what I would encourage people to do, to keep their eye on the fundamentals of cost reduction and CapEx reduction, which are sometimes overlooked facets of this industry.

Everybody's been so fixated on subscriber growth and revenue growth for years that I think they lose sight of the fact that there is a very positive underlying trend going on in the cost structures, whether it's GenAI, whether it's new network technologies, whether it's self-installation at your homes so they don't have to send a truck roll. Across the board, there are substantial cost reductions going on, which means a lot of these companies can still generate mid-single digit, even high-single digit cash flow growth, even if their revenue growth is almost zero. So I would leave it there for now, and without getting into specific names, but there are certainly some names that are better set up for that than others. [AUDIO LOGO]

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