Telecom stocks have appeal for investors looking for dividend growth

Yields are attractive, but other fundamentals look bleak for Canada's Big Three.

Michael Leonard 13 March, 2014 | 6:00PM
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Canadian telecommunications stocks face adversity on the regulatory front that has contributed to their lacklustre market performance and clouded their future prospects. Even so, telecom giants BCE Inc. BCE, Telus Corp. T and Rogers Communications Inc. RCI.B should draw interest from investors who are focused on dividend growth.

The latest salvo against telecom's Big Three -- which control approximately 91% of the wireless market and whose stock prices struggled to keep up with the S&P/TSX Composite Index in 2013 -- came in the Feb. 12 federal budget. Finance Minister Jim Flaherty announced that legislation would be introduced to cap wholesale domestic wireless roaming rates and impose penalties on companies that violate regulatory requirements.

This was confirmation of an earlier announcement on Dec. 18 of the government's intentions to limit what the Big Three could charge their smaller rivals for network access. Currently, these fees are often much higher than what the Big Three charge their own customers.

Ottawa's plan to cap wholesale wireless rates follows its failed initiative last year to entice the U.S. giant Verizon Communications Inc. VZ. By acquiring small Canadian wireless carriers Wind and Mobilicity, Verizon could have competed directly in Canada with the Big Three.

Despite Verizon's Aug. 15 announcement that it would not immediately seek to enter the market, Ottawa kept up its high-profile advertising campaign to promote more wireless competition, with radio and TV commercials running for the remainder of 2013.

BCE is the 11th largest stock in Canada based on its $36-billion market float. Among the factors that are attractive to income-oriented investors are its 5.3% expected dividend yield, its 19% annualized dividend growth over the past five years and its near-zero price beta.

BCE's valuations are market-like or worse, and its values for the so-called alpha-generators (earnings surprise, quarterly earnings momentum and analysts' estimate revisions) are drab at best.

Furthermore, a check of BCE's historic valuations reveals that at its current price-to-book ratio of just over three times, the only period in the past 32 years in which BCE was more expensive than currently was in 1998 through 2000. Beyond access to the secure dividend, there appears to be no reason to own BCE.

Meanwhile, Telus's profile looks quite similar. Earnings momentum and analysts' estimate revisions of fiscal earnings are marginally positive, but not enough to elevate Telus into Buy territory for any investment style other than dividend growth.

Furthermore, Telus stock recently traded at a price-to-book ratio of 3.4 times, representing its highest value since the company starting trading publicly in 1999. Does this indicate that Telus stock is destined to recede? Not necessarily. It could continue to trade at this valuation or even higher. However, Telus stock cannot be construed as "good value." It is also trading at 17.8 times trailing earnings per share and 16.6 times the 2014 median of analysts' fiscal EPS estimates.

Rogers offers more of the same but for one exception: in addition to its 4.2% expected dividend yield, Rogers stock also shows a growth profile due to strong growth-of-book-value metrics. Its reinvestment rate (growth of book value) on a trailing basis is 18.5%, while on the 2014 analysts' fiscal earnings consensus, book value would grow by 16%. Rogers demonstrates the relatively rare feat of being considered "growth" and "income" simultaneously.

However, values for the alpha-generators are all weak, indicating little reason to get excited about Rogers. At least the valuations picture is less intimidating than for its large Canadian peers. At a P/B multiple of about 4.8 times, Rogers stock currently trades near the mid-point of its valuation range dating back to 2003.

There certainly appears to be nothing overly compelling in the fundamental attributes of any of these stocks that should garner serious consideration from investors. Even those looking to add to a dividend-growth-oriented portfolio can find more attractive Canadian stocks to buy.

And what of Verizon, the former threat to the Big Three? While exhibiting many of the same fundamental income-oriented attributes as its Canadian cousins, the stock also appeals to value investors.

Among Verizon's shining attributes, it trades at 3.5 times its trailing cash flow, which is among the best values observed for any of the 2150 stocks in the Morningstar CPMS U.S. universe. It also trades a P/B ratio of 3.6 -- 25% below its historic peak of 4.8 recorded in 2013.

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Michael Leonard

Michael Leonard  Michael Leonard, CFA, is chief equity strategist at Morningstar Canada.

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