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Canada’s big telecom stocks have been underperforming broader markets this past year. Vince Valentini, Managing Director for Equity Research at TD Cowen, gives his outlook for the industry and potential opportunities for investors.
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* The big Canadian telecom stocks have underperformed the broader markets over the past year, but are there any signs of better days ahead in their latest earnings reports? For more on this, we're joined by Vince Valentini, Managing Director of Equity Research at TD Cowen, which is a division of TD Securities. Vince, welcome to the program, your first time on. We're looking forward to the chat.
* Thanks very much, Greg. Thrilled to be here.
* All right, so telecom stocks. Obviously, these are some of the biggest names on the TSX Composite index. People are well-acquainted with them. They're thought of blue chip steady-eddies. It hasn't been an easy go for them in the past year or so. What have we been seeing? What are we seeing in the telecom industry overall?
* Let me give you my thoughts just about the industry from a big picture level to start with, and we can drill down into some of the detail over what's happened in the past 12 months, or more recently. In general, I've been covering this sector for 30 years, to put this in context. So there's obviously something here I like because I've stuck with it. I think it is a good industry.
* First off, they sell what are pretty much non-discretionary services. Everybody needs their cell phone. Everybody needs their internet connection. These companies provide the plumbing to make those services happen. So it really is digital infrastructure that's never going away. I like that long life infrastructure characteristic of the industry.
* Second is we have a pretty good regulatory system in Canada. There's always ebbs and flows, and you have criticisms at times, but for the most part, we have a self-contained Canadian industry with strict foreign ownership rules. That provides a huge barrier to entry, that we're never going to face competition from the likes of T-Mobile or a Vodafone, somebody who would have much bigger scale and potentially disrupt the apple cart for our existing players.
* So I think that gives a good foundation for investors, which brings you back to what these companies do. They're not high growth entities, but they generate stable, slightly growing cash flow, which they then deploy into share buybacks or dividends or sometimes pad their growth with acquisitions. So at a high level, I think the industry is well-positioned for the longer term.
* And last but not least, it is not overly expensive, considering the type of infrastructure they have. If we look at virtually every other class of infrastructure assets, whether you want to look at pipelines or railways, green energy projects, a lot of times, those trade in the range of 10 to 15 times EBITDA. Telco's trading at 7 to 8. And at one point, they were up at 9, so they've come down a little bit, but generally hover in the 7 to 8 times range. So I think you're getting pretty decent long life cash flow at a reasonable valuation. So I like where we are. I'll pause there if you want to dig more into the last year.
* I mean, that's the reason why we often think of these as the blue chips and the steady-eddies. You take a look at the last year and you look at the stock market performance of a BCE or a Telus or a Rogers, even against the TSX-- and the TSX isn't gangbusters in the past year either, but they're dramatically underperforming. What are we seeing in these names? And was there anything in the results that start moving us forward in this story?
* Let me deal with last year first. Really, I hate to admit it as a fundamental analyst because we're paid to dig into the weeds of what the companies are doing and who's doing better than another in terms of marketing and managing their cost structure and all that good stuff. But at the end of the day, 70% of the battle with these stocks is bond yields. They are simply cash generators, and people look at the dividend yields and weigh that versus where bond yields are. Almost like bond proxies in some extreme cases.
* The biggest issue last year was clearly, after many, many years of ultra low interest rates, we finally saw rates rising and bond yields up quite significantly. So magically, after the peak in October, from October to the end of December, you saw the telcos rally, which was, again, largely bond yields coming back down. So if you're constructive on the outlook for bond yields, which our teams at TD Economics are, that they will be lower a year from now, then I think these stocks will have a much better year. Last couple of days, it's been a little rocky on that front with the CPI numbers, so there's always going to be a bit of volatility. But in general, I think that headwind will turn into a tailwind and help most of the stocks in the sector.
* In addition to that, Greg, there were a couple of fundamental factors last year that scared people a bit more than normal. We had some major transformational, I'd call it, M&A activity in the space with Rogers acquiring Shaw cable. And then the spinoff of Shaw's wireless business, Freedom Mobile, had to go to Québecor in order to get regulatory approval.
* That created a lot of consternation in the investment community as to what's this new world going to look like. Are we going to have dramatically more competition than we're used to? Any sort of price wars, especially from that new player, Québecor, who had acquired Freedom Mobile and become, pretty much, a national wireless carrier for the first time?
* So I think there was a lot of, I would call, noise in hindsight, that we could have price wars. Hasn't really turned out to be the case. There is certainly competition in the market, but nothing I would call outsized. But for a few months last year, there were concerns that things would get worse than they did.
* And the last point, I'd say, is just regulatory, which somewhat linked to the Rogers-Shaw deal, as well, that would the government and the CRTC come out firing after that deal, saying we let the industry consolidate? Now we're going to hammer you with more stringent regulations, potentially forcing you to open up access to your networks at super cheap rates for resellers to come in, and various other sort of small regulatory files that were on the docket last year.
* Again, a lot of concern from some analysts on Bay Street, which really didn't materialize. We saw a couple of regulatory outcomes late last year, which were very favorable. Showed that it's steady as she goes. The government, at a high level, likes the industry. No politician can admit that very easily, but the industry invests very well in high quality networks. They want to incentivize investment.
* So they're probably not going to do anything devastating to really hurt them, is my view, and we saw more evidence of that last year. But to your point, bond yields rising, competitive concerns, and some elevated regulatory concerns, which have now, pretty much, fallen by the wayside, is why things didn't do very well last year and why I'm pretty constructive over the next 12 months.
* You mentioned some big names there. For the audience, for the full disclosure on the companies that are covered by TD Cowen, you can see the link to the TD Securities website at the end of this program. So that takes us through what we've been through. We recently had a batch of earnings, and of course, not only is it important, the three months behind them, but what they're saying about the path in front of them. As you went through those earnings for these big companies, does anything stand out? Anything interesting investors need to be aware of?
* Yes, Greg. So we did. Just to level set for everybody watching, in the past two weeks, we've had BCE, Telus, and Rogers all report their fourth quarter results. This is a pretty important quarter because at this time of the year, they almost always give us their annual guidance for the following year. So we got 2024 guidance from all three of those companies.
* I would say a couple of wrinkles and things to be concerned about, but for the most part, the results were quite encouraging. First point I'd probably say is the wireless market remains very strong. Canada has gone through a couple of years of record levels of subscriber additions, in part driven by immigration and foreign students, but also just people adopting more devices than they ever have in the past. So we had, 2023, total industry wireless subscriber additions up around 1.75 million, which was right in line with 2022, which was an all-time record year. That's about 5% growth in volume for the industry. So we saw evidence of that in the fourth quarter results.
* We saw nothing in the guidance from any of the companies to suggest that that pace of growth is going to slow down dramatically. Rogers has indicated 4% to 4.5% for 2024 is where they think it can settle in, which factors in some of what the government is doing to limit foreign student visas. But it's not going to crater the industry growth. It just slows it down a little from a very high level. So the results were encouraging in terms of that underlying volume growth.
* We also saw stable ARPU, which goes back to what I was talking about earlier.
* Average Revenue Per User, right?
* Average Revenue--
* I just remembered some of my acronyms from when I used to have to cover these things first off when they broke.
* Apologies. We have a lot of acronyms in the industry, and I throw them out pretty quickly sometimes. So yes, catch me on any of that. Average Revenue Per User, which is a key metric of, what are the wireless carriers getting from each customer per month? If that metric starts to decline, then we get concerned that there is too much competition and volume growth is being offset with pricing, and you don't get the revenue and profit growth that you should be getting.
* We saw ARPU relatively stable, which refutes some of that noise I was talking about in sort of the middle part of last year, that people thought we were going to have price wars and elevated competition after Québecor took over Freedom. So no evidence of that in the fourth quarter results either.
* And now back to the ebb and flow I mentioned. Not everything was perfect. Some carriers certainly seemed to be executing better than others at getting their share of that volume growth, managing their cost structure well, which all translates into the most important metric for most analysts, like myself, is EBITDA growth, which ultimately is a proxy for free cash flow. But free cash flow runs around every year with all kinds of lumpy items, so we tend to focus mostly on EBITDA as the main comparative metric.
* On that front, we saw guidance from Rogers for 6% to 9% growth in 2024. Telus is at 5.5% to 7.5% and BCE is at 1.5% to 4.5%. So clearly, Rogers seems to be doing a bit better. And to be clear, that is organic growth for all three of them. I've backed out the Shaw contribution for one extra quarter that they've acquired it for in 2024. So some better execution from some versus others was notable in the numbers.
* And then last, but not least, is free cash flow and dividend quality, which is very important to investors in this space, especially for BCE and Telus, which are the two highest yielding names. And there we saw pretty good performance from Telus-- free cash flow guidance in line with what we thought, seemingly supportive of them continuing what they've been promising for some time, which is to do at least 7% per year dividend growth, whereas BCE slowed their dividend growth for the first time in 15 years. They had been doing 5%. They lowered it to 3%. And their free cash flow growth guidance for 2024 was quite a bit below what most people were expecting, and they're expecting a decline of between 3% and 5%.
* So, again, Greg, not everything was perfect in the results. There are a couple of weak spots, depending on which company you look at. But at a high level, the market growth and market pricing dynamics were clearly still trending in the right direction.
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* The big Canadian telecom stocks have underperformed the broader markets over the past year, but are there any signs of better days ahead in their latest earnings reports? For more on this, we're joined by Vince Valentini, Managing Director of Equity Research at TD Cowen, which is a division of TD Securities. Vince, welcome to the program, your first time on. We're looking forward to the chat.
* Thanks very much, Greg. Thrilled to be here.
* All right, so telecom stocks. Obviously, these are some of the biggest names on the TSX Composite index. People are well-acquainted with them. They're thought of blue chip steady-eddies. It hasn't been an easy go for them in the past year or so. What have we been seeing? What are we seeing in the telecom industry overall?
* Let me give you my thoughts just about the industry from a big picture level to start with, and we can drill down into some of the detail over what's happened in the past 12 months, or more recently. In general, I've been covering this sector for 30 years, to put this in context. So there's obviously something here I like because I've stuck with it. I think it is a good industry.
* First off, they sell what are pretty much non-discretionary services. Everybody needs their cell phone. Everybody needs their internet connection. These companies provide the plumbing to make those services happen. So it really is digital infrastructure that's never going away. I like that long life infrastructure characteristic of the industry.
* Second is we have a pretty good regulatory system in Canada. There's always ebbs and flows, and you have criticisms at times, but for the most part, we have a self-contained Canadian industry with strict foreign ownership rules. That provides a huge barrier to entry, that we're never going to face competition from the likes of T-Mobile or a Vodafone, somebody who would have much bigger scale and potentially disrupt the apple cart for our existing players.
* So I think that gives a good foundation for investors, which brings you back to what these companies do. They're not high growth entities, but they generate stable, slightly growing cash flow, which they then deploy into share buybacks or dividends or sometimes pad their growth with acquisitions. So at a high level, I think the industry is well-positioned for the longer term.
* And last but not least, it is not overly expensive, considering the type of infrastructure they have. If we look at virtually every other class of infrastructure assets, whether you want to look at pipelines or railways, green energy projects, a lot of times, those trade in the range of 10 to 15 times EBITDA. Telco's trading at 7 to 8. And at one point, they were up at 9, so they've come down a little bit, but generally hover in the 7 to 8 times range. So I think you're getting pretty decent long life cash flow at a reasonable valuation. So I like where we are. I'll pause there if you want to dig more into the last year.
* I mean, that's the reason why we often think of these as the blue chips and the steady-eddies. You take a look at the last year and you look at the stock market performance of a BCE or a Telus or a Rogers, even against the TSX-- and the TSX isn't gangbusters in the past year either, but they're dramatically underperforming. What are we seeing in these names? And was there anything in the results that start moving us forward in this story?
* Let me deal with last year first. Really, I hate to admit it as a fundamental analyst because we're paid to dig into the weeds of what the companies are doing and who's doing better than another in terms of marketing and managing their cost structure and all that good stuff. But at the end of the day, 70% of the battle with these stocks is bond yields. They are simply cash generators, and people look at the dividend yields and weigh that versus where bond yields are. Almost like bond proxies in some extreme cases.
* The biggest issue last year was clearly, after many, many years of ultra low interest rates, we finally saw rates rising and bond yields up quite significantly. So magically, after the peak in October, from October to the end of December, you saw the telcos rally, which was, again, largely bond yields coming back down. So if you're constructive on the outlook for bond yields, which our teams at TD Economics are, that they will be lower a year from now, then I think these stocks will have a much better year. Last couple of days, it's been a little rocky on that front with the CPI numbers, so there's always going to be a bit of volatility. But in general, I think that headwind will turn into a tailwind and help most of the stocks in the sector.
* In addition to that, Greg, there were a couple of fundamental factors last year that scared people a bit more than normal. We had some major transformational, I'd call it, M&A activity in the space with Rogers acquiring Shaw cable. And then the spinoff of Shaw's wireless business, Freedom Mobile, had to go to Québecor in order to get regulatory approval.
* That created a lot of consternation in the investment community as to what's this new world going to look like. Are we going to have dramatically more competition than we're used to? Any sort of price wars, especially from that new player, Québecor, who had acquired Freedom Mobile and become, pretty much, a national wireless carrier for the first time?
* So I think there was a lot of, I would call, noise in hindsight, that we could have price wars. Hasn't really turned out to be the case. There is certainly competition in the market, but nothing I would call outsized. But for a few months last year, there were concerns that things would get worse than they did.
* And the last point, I'd say, is just regulatory, which somewhat linked to the Rogers-Shaw deal, as well, that would the government and the CRTC come out firing after that deal, saying we let the industry consolidate? Now we're going to hammer you with more stringent regulations, potentially forcing you to open up access to your networks at super cheap rates for resellers to come in, and various other sort of small regulatory files that were on the docket last year.
* Again, a lot of concern from some analysts on Bay Street, which really didn't materialize. We saw a couple of regulatory outcomes late last year, which were very favorable. Showed that it's steady as she goes. The government, at a high level, likes the industry. No politician can admit that very easily, but the industry invests very well in high quality networks. They want to incentivize investment.
* So they're probably not going to do anything devastating to really hurt them, is my view, and we saw more evidence of that last year. But to your point, bond yields rising, competitive concerns, and some elevated regulatory concerns, which have now, pretty much, fallen by the wayside, is why things didn't do very well last year and why I'm pretty constructive over the next 12 months.
* You mentioned some big names there. For the audience, for the full disclosure on the companies that are covered by TD Cowen, you can see the link to the TD Securities website at the end of this program. So that takes us through what we've been through. We recently had a batch of earnings, and of course, not only is it important, the three months behind them, but what they're saying about the path in front of them. As you went through those earnings for these big companies, does anything stand out? Anything interesting investors need to be aware of?
* Yes, Greg. So we did. Just to level set for everybody watching, in the past two weeks, we've had BCE, Telus, and Rogers all report their fourth quarter results. This is a pretty important quarter because at this time of the year, they almost always give us their annual guidance for the following year. So we got 2024 guidance from all three of those companies.
* I would say a couple of wrinkles and things to be concerned about, but for the most part, the results were quite encouraging. First point I'd probably say is the wireless market remains very strong. Canada has gone through a couple of years of record levels of subscriber additions, in part driven by immigration and foreign students, but also just people adopting more devices than they ever have in the past. So we had, 2023, total industry wireless subscriber additions up around 1.75 million, which was right in line with 2022, which was an all-time record year. That's about 5% growth in volume for the industry. So we saw evidence of that in the fourth quarter results.
* We saw nothing in the guidance from any of the companies to suggest that that pace of growth is going to slow down dramatically. Rogers has indicated 4% to 4.5% for 2024 is where they think it can settle in, which factors in some of what the government is doing to limit foreign student visas. But it's not going to crater the industry growth. It just slows it down a little from a very high level. So the results were encouraging in terms of that underlying volume growth.
* We also saw stable ARPU, which goes back to what I was talking about earlier.
* Average Revenue Per User, right?
* Average Revenue--
* I just remembered some of my acronyms from when I used to have to cover these things first off when they broke.
* Apologies. We have a lot of acronyms in the industry, and I throw them out pretty quickly sometimes. So yes, catch me on any of that. Average Revenue Per User, which is a key metric of, what are the wireless carriers getting from each customer per month? If that metric starts to decline, then we get concerned that there is too much competition and volume growth is being offset with pricing, and you don't get the revenue and profit growth that you should be getting.
* We saw ARPU relatively stable, which refutes some of that noise I was talking about in sort of the middle part of last year, that people thought we were going to have price wars and elevated competition after Québecor took over Freedom. So no evidence of that in the fourth quarter results either.
* And now back to the ebb and flow I mentioned. Not everything was perfect. Some carriers certainly seemed to be executing better than others at getting their share of that volume growth, managing their cost structure well, which all translates into the most important metric for most analysts, like myself, is EBITDA growth, which ultimately is a proxy for free cash flow. But free cash flow runs around every year with all kinds of lumpy items, so we tend to focus mostly on EBITDA as the main comparative metric.
* On that front, we saw guidance from Rogers for 6% to 9% growth in 2024. Telus is at 5.5% to 7.5% and BCE is at 1.5% to 4.5%. So clearly, Rogers seems to be doing a bit better. And to be clear, that is organic growth for all three of them. I've backed out the Shaw contribution for one extra quarter that they've acquired it for in 2024. So some better execution from some versus others was notable in the numbers.
* And then last, but not least, is free cash flow and dividend quality, which is very important to investors in this space, especially for BCE and Telus, which are the two highest yielding names. And there we saw pretty good performance from Telus-- free cash flow guidance in line with what we thought, seemingly supportive of them continuing what they've been promising for some time, which is to do at least 7% per year dividend growth, whereas BCE slowed their dividend growth for the first time in 15 years. They had been doing 5%. They lowered it to 3%. And their free cash flow growth guidance for 2024 was quite a bit below what most people were expecting, and they're expecting a decline of between 3% and 5%.
* So, again, Greg, not everything was perfect in the results. There are a couple of weak spots, depending on which company you look at. But at a high level, the market growth and market pricing dynamics were clearly still trending in the right direction.
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