Stock Smarts: Telecoms Under Pressure

Ottawa’s attempt to create a fourth wireless carrier is bad news for the shares of Rogers, BCE, and Telus

It has not been a good year for Canada’s telecommunications sector.

As of the close of trading on Aug. 15, the S&P/TSX Capped Telecom Services Index was ahead only 2.3 per cent for the year – barely above break-even. That placed it in the unenviable position of being the worst performing sector on the Toronto Stock Exchange.

What’s happened? It’s not as if our telecom companies are going broke – in fact, in broad terms they’re performing reasonably well. Part of the problem is that investors don’t see a lot of upside potential in the shares right now. Much of the blame for that can be laid at the doorstep of the Conservative government in Ottawa. Its quixotic attempts to encourage the creation of a fourth major wireless provider in Canada have so far achieved nothing more than to raise a cloud of uncertainty over one of our most important industries.

The government’s latest manoeuvre is the plan to auction off more wireless spectrum on terms that are supposed to encourage a potential competitor to step forward. More than half of the 50 megahertz of AWS-3 wireless spectrum, which will be sold in early 2015, is being allocated to small companies. (AWS stands for advanced wireless spectrum.) Previous auctions were dominated by the Big Three of Rogers, BCE, and Telus, which control 95 per cent of the wireless market in Canada. Moreover, regulations will make it difficult for a smaller company to resell any spectrum it purchases to one of the Big Three at a later date.

Growth in the wireless sector is seen as the key to future profit gains for the telecoms, with traditional cable and wireline revenues under pressure as more customers cut the cord. If Ottawa somehow succeeds in its efforts to create a viable fourth player, investors and analysts believe the inevitable result will be to draw business away from the Big Three. Without strong wireless growth, they’ll stagnate.

Even without a fourth player, the Big Three are coming under pressure in the wireless sector, with Rogers Communications (TSX: RCI.B, NYSE: RCI) hurting the most. The company’s second-quarter results showed that operating revenue from wireless was down 1 per cent year-over-year. Net postpaid wireless additions (the most-watched statistic) were down 60 per cent for the quarter and 90 per cent for the first six months of fiscal 2014. The company blamed a previous government policy, the outlawing of three-year contracts, for the dramatic slowdown in growth.

The weak wireless performance contributed to a drop of 13 per cent in the company’s second-quarter profits. Year-to-date, net earnings at Rogers are off 15 per cent from 2013.

All of these factors contributed to our advice to sell Rogers shares last month. But what about the other two large telecoms, BCE and Telus?

Both companies reported second-quarter results earlier this month and in both cases we saw the same phenomenon – a slowdown in wireless growth. However, the results weren’t as dramatic as in the case of Rogers.

NEXT: BCE Results

BCE results

BCE (TSX, NYSE: BCE) reported a 5.5 per cent increase in wireless operating revenue for the quarter to just over $1.5 billion. Postpaid net additions totalled 66,186 compared to 96,390 last year, down 31 per cent. Like Rogers, the company blamed the drop to “slower overall market growth resulting from the elimination of lower-priced 3-year contracts as mandated by the new federal Wireless Code of Conduct”.

Overall, the company’s second-quarter results continue to show strength. BCE reporting operating revenue of $4.22 billion, up 4.4 per cent from the same period in 2013. Net earnings attributable to common shareholders were $606 million ($0.78 per share), an improvement of 6.1 per cent from $571 million ($0.74 per share) a year ago.

I have a friend who runs down BCE stock every time we discuss the market. It’s a badly managed company, he insists, and its media operations are highly vulnerable to a downturn in advertising.

I agree about his comments relating to advertising and in fact Bell Media is in the process of severing 120 employees due to softness in the TV ad market. Despite this, Bell Media posted a revenue increase of 36.1 per cent to $761 million for the quarter, due mainly to last year’s acquisition of Astral Communications.

As for bad management, it seems to me the company has done very well for investors since the bid to take it private collapsed in December 2008, shortly before I recommended the stock in my Internet Wealth Builder newsletter. We have more than doubled our money and we’re receiving a dividend yield of 11.6 per cent based on the original recommended price. I doubt many people are unhappy with that. Based on the current price, the stock yields 5.1 per cent.

Of course, as we always say in the investment business, past results are no guarantee of future returns. But I see BCE as a solid, multi-faceted business. It’s not going to crash and burn any time soon. The decision to purchase the balance of the shares in Bell Aliant that it didn’t already own will add to BCE’s revenue and profitability in the years to come.

NEXT: Telus Reports Financials

Telus reports financials

Telus (TSX: T, NYSE: TU) also had a good second quarter. Operating revenue was up 4.4 per cent to just under $3 billion, meeting analysts’ expectations. Adjusted net income, which strips out unusual costs and revenue, rose 9.3 per cent to $387 million ($0.63 per share). On an earnings per share basis, that was a 16.7 per cent improvement over the same period in 2013. Free cash flow was up 9.4 per cent to $210 million.

Wireless network revenues increased by $85 million (6.1 per cent) to $1.5 billion in the quarter. The growth was driven by continued subscriber base expansion, higher data usage as a result of a continued increase in smartphone adoption, the expansion of the company’s LTE network coverage, and increased data roaming.

However, like the other two majors, new wireless activations were down. Telus reported net additions of 58,000, compared to 79,000 a year ago, a decline of 27 per cent. The total wireless subscriber base was up by 170,000 from a year ago to 7.9 million, a 2.2 per cent increase. Higher-value postpaid subscribers represent 87 per cent of the total subscriber base.

Telus CEO Darren Entwistle didn’t comment directly on Ottawa’s policies in his remarks accompanying the financial results. But he reminded investors and, by extension, federal politicians of the huge investments the Big Three have made in creating a national telecom network.

“The Canadian telecommunications industry represents an intensely competitive and rapidly changing market where carriers are required to meet the evolving demands of our customers in respect of service excellence,” he said.

“Despite being challenged with a vast and tremendously diverse geographic landscape and dispersed population, our high quality networks have become the envy of the world owing to the fact that they have been built in a regulatory environment that requires meaningful facilities based investment. Telus alone has committed $111 billion in technology and operations since 2000 to bridge the digital divide by providing best-in-class technology and wireless coverage to 99 per cent of the Canadian population.”

The message may have been veiled but it was clear – we’ve spent billions setting up the network. Allowing a new competitor to piggyback on it now would be patently unfair.

Despite everything, Telus is doing well enough to reward with a dividend increase of 11.8 per cent to $0.38 per quarter ($1.52 annually), effective with the Oct. 1 payment. This boosts the forward yield on the shares to 3.95 per cent based on Friday’s closing price. That’s well below the yield for BCE, suggesting that investors see Telus as having more growth potential.

Telus also continues to actively buy back shares through its normal course issuer bid. As of July 31, the company had purchased 10.7 million shares thus far in 2014 at an average price of $38.34 for a total cost of $410 million.

The bottom line is that I expect both Telus and BCE to provide decent but not spectacular returns over the next year. If Ottawa finally decides to quietly abandon its seemingly futile efforts to create a fourth major wireless player that could boost the shares of all of the Big Three telecoms. But don’t hold your breath. Stephen Harper is one stubborn dude.

Gordon Pape’s new book, RRSPs: The Ultimate Wealth Builder, is now available for purchase at 28% off the suggested retail price. For information on a three-month trial subscription to Gordon Pape’s Income Investor newsletter go here.